Conditional Volatility and Correlations of Weekly Returns and the VaR Analysis of 2008 Stock Market
AbstractModelling of conditional volatilities and correlations across asset returns is an integral part of portfolio decision making and risk management. Over the past three decades there has been a trend towards increased asset return correlations across markets, a trend which has been accentuated during the recent financial crisis. We shall examine the nature of asset return correlations using weekly returns on futures markets and investi- gate the extent to which multivariate volatility models proposed in the literature can be used to formally characterize and quantify market risk. In particular, we ask how adequate these models are for modelling market risk at times of financial crisis. In doing so we consider a multivariate t version of the Gaussian dynamic conditional correlation (DCC) model proposed by Engle (2002), and show that the t-DCC model passes the usual diagnostic tests based on probability integral transforms, but fails the value at risk (VaR) based diagnostics when applied to the post 2007 period that includes the recent financial crisis.
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Bibliographic InfoPaper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 1025.
Date of creation: 29 May 2010
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Volatilities and Correlations; Weekly Returns; Multivariate t; Financial Interdependence; VaR diagnostics; 2008 Stock Market Crash;
Find related papers by JEL classification:
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-06-04 (All new papers)
- NEP-BEC-2010-06-04 (Business Economics)
- NEP-RMG-2010-06-04 (Risk Management)
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- Thomas Dimpfl & Robert Jung, 2011. "Financial market spillovers around the globe," Global Financial Markets Working Paper Series 20-2011, Friedrich-Schiller-University Jena.
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