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Worst-Case Higher Moment Risk Measure: Addressing Distributional Shifts and Procyclicality

Author

Listed:
  • Castro-Iragorri, Carlos

    (Facultad de Economía Universidad del Rosario)

  • Gómez, Fabio

    (Facultad de Economía Universidad del Rosario)

  • Quiceno, Nancy

    (Camara de Riesgo Central de Contraparte, CRCC)

Abstract

This paper addresses the inherent procyclicality in widely adopted financial risk measures, such as Expected Shortfall (ES). We propose an innovative approach utilizing the Higher Moment (HM) risk measure, which offers a robust solution to distributional shifts by incorporating adaptive features. Empirical results using historical S&P500 returns indicate that worst-case HM risk measures significantly reduce the underestimation of risk and provide more stable risk assessments throughout the financial cycle compared to traditional ES predictions. These results suggest that HM risk measures represent a viable alternative to regulatory add-ons for stress testing and procyclicality mitigation in financial risk management.

Suggested Citation

  • Castro-Iragorri, Carlos & Gómez, Fabio & Quiceno, Nancy, 2024. "Worst-Case Higher Moment Risk Measure: Addressing Distributional Shifts and Procyclicality," Documentos de Trabajo 21048, Universidad del Rosario.
    • Handle: RePEc:col:000092:021048
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    More about this item

    Keywords

    procyclicality; higher moment risk; stress testing; expected shortfall;
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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