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Monte-Carlo Estimations of the Downside Risk of Derivative Portfolios

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  • Patrick Leoni

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    (Economics Department, National University of Ireland, Maynooth)

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    Abstract

    We simulate the performances of a standard derivatives portfolio to evaluate the relevance of benchmarking in terms of downside risk reduction. The simulation shows that benchmarking always leads to significantly more severe losses in average than those generated by letting the portfolio reach the end of a given horizon. Moreover, switching from a 0-correlation across underlyings to a very mild form of correlation significantly increases the probability of reaching the downside benchmark before maturity, whereas adding more correlation does not significantly increase this figure.

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    File URL: http://economics.nuim.ie/sites/economics.nuim.ie/files/working-papers/N1760607.pdf
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    Bibliographic Info

    Paper provided by Department of Economics, Finance and Accounting, National University of Ireland - Maynooth in its series Economics, Finance and Accounting Department Working Paper Series with number n1760607.

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    Length: 23 pages
    Date of creation: 2007
    Date of revision:
    Handle: RePEc:may:mayecw:n1760607

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    Postal: Maynooth, Co. Kildare
    Phone: 353-1-7083728
    Fax: 353-1-7083934
    Web page: http://economics.nuim.ie
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    Related research

    Keywords: : Derivatives; Portfolio management; Benchmarking; Downside risk; Monte-Carlo simulations.;

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    1. Jun Liu & Francis A. Longstaff & Jun Pan, 2002. "Dynamic Asset Allocation With Event Risk," NBER Working Papers 9103, National Bureau of Economic Research, Inc.
    2. Corwin Joy & Phelim P. Boyle & Ken Seng Tan, 1996. "Quasi-Monte Carlo Methods in Numerical Finance," Management Science, INFORMS, vol. 42(6), pages 926-938, June.
    3. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
    4. Ning Du & David V. Budescu, 2005. "The Effects of Imprecise Probabilities and Outcomes in Evaluating Investment Options," Management Science, INFORMS, vol. 51(12), pages 1791-1803, December.
    5. Boyle, Phelim & Broadie, Mark & Glasserman, Paul, 1997. "Monte Carlo methods for security pricing," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1267-1321, June.
    6. Robert Jarrow & Feng Zhao, 2006. "Downside Loss Aversion and Portfolio Management," Management Science, INFORMS, vol. 52(4), pages 558-566, April.
    7. Suleyman Basak & Alex Shapiro & Lucie Teplá, 2006. "Risk Management with Benchmarking," Management Science, INFORMS, vol. 52(4), pages 542-557, April.
    8. Jérôme Detemple & René Garcia & Marcel Rindisbacher, 2005. "Asymptotic Properties of Monte Carlo Estimators of Derivatives," Management Science, INFORMS, vol. 51(11), pages 1657-1675, November.
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