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An automatic procedure for the estimation of the tail index

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  • Gimeno, Ricardo
  • Gonzalez, Clara I.

Abstract

Extreme Value Theory is increasingly used in the modelling of financial time series. The non-normality of stock returns leads to the search for alternative distributions that allows skewness and leptokurtic behavior. One of the most used distributions is the Pareto Distribution because it allows non-normal behaviour, which requires the estimation of a tail index. This paper provides a new method for estimating the tail index. We propose an automatic procedure based on the computation of successive normality tests over the whole of the distribution in order to estimate a Gaussian Distribution for the central returns and two Pareto distributions for the tails. We find that the method proposed is an automatic procedure that can be computed without need of an external agent to take the decision, so it is clearly objective.

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File URL: http://mpra.ub.uni-muenchen.de/37023/
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 37023.

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Date of creation: 2012
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Handle: RePEc:pra:mprapa:37023

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Keywords: Tail Index; Hill estimator; Normality Test;

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  1. McCulloch, J Huston, 1997. "Measuring Tail Thickness to Estimate the Stable Index Alpha: A Critique," Journal of Business & Economic Statistics, American Statistical Association, vol. 15(1), pages 74-81, January.
  2. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  3. Dennis Jansen & Casper de Vries, 1988. "On the frequency of large stock returns: putting booms and busts into perspective," Working Papers 1989-006, Federal Reserve Bank of St. Louis.
  4. Philipp Hartmann & Jon Danielsson, 1998. "The Cost of Conservatism: Extreme Returns, Value-at Risk, and the Basle Multiplicaiton Factor," FMG Special Papers sp100, Financial Markets Group.
  5. Eugene F. Fama, 1963. "Mandelbrot and the Stable Paretian Hypothesis," The Journal of Business, University of Chicago Press, vol. 36, pages 420.
  6. Mittnik, Stefan & Paolella, Marc S. & Rachev, Svetlozar T., 2000. "Diagnosing and treating the fat tails in financial returns data," Journal of Empirical Finance, Elsevier, vol. 7(3-4), pages 389-416, November.
  7. Benoit Mandelbrot, 1963. "The Variation of Certain Speculative Prices," The Journal of Business, University of Chicago Press, vol. 36, pages 394.
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