Advanced Search
MyIDEAS: Login

Why VAR Fails: Long Memory and Extreme Events in Financial Markets

Contents:

Author Info

  • Cornelis A. Los

Abstract

The Value-at-Risk (VAR) measure is based on only the second moment of a rates of return distribution. It is an insufficient risk performance measure, since it ignores both the higher moments of the pricing distributions, like skewness and kurtosis, and all the fractional moments resulting from the long - term dependencies (long memory) of dynamic market pricing. Not coincidentally, the VaR methodology also devotes insufficient attention to the truly extreme financial events, i.e., those events that are catastrophic and that are clustering because of this long memory. Since the usual stationarity and i.i.d. assumptions of classical asset returns theory are not satisfied in reality, more attention should be paid to the measurement of the degree of dependence to determine the true risks to which any investment portfolio is exposed: the return distributions are time-varying and skewness and kurtosis occur and change over time. Conventional mean-variance diversification does not apply when the tails of the return distributions ate too fat, i.e., when many more than normal extreme events occur. Regrettably, also, Extreme Value Theory is empirically not valid, because it is based on the uncorroborated i.i.d. assumption.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://128.118.178.162/eps/fin/papers/0412/0412014.pdf
Download Restriction: no

Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0412014.

as in new window
Length: 26 pages
Date of creation: 08 Dec 2004
Date of revision:
Handle: RePEc:wpa:wuwpfi:0412014

Note: Type of Document - pdf; pages: 26
Contact details of provider:
Web page: http://128.118.178.162

Related research

Keywords: Long memory; Value at Risk; Extreme Value Theory; Portfolio Management; Degrees of Persistence;

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  2. Eugene F. Fama, 1965. "Portfolio Analysis in a Stable Paretian Market," Management Science, INFORMS, vol. 11(3), pages 404-419, January.
  3. Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
  4. Sornette, Didier, 1998. "Large deviations and portfolio optimization," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 256(1), pages 251-283.
  5. Cornelis A. Los, 2004. "When to Put All Your Eggs in One Basket.....When Diversification Increases Portfolio Risk!," Finance 0411037, EconWPA.
  6. Koedijk, C.G. & Schafgans, M.M.A. & Vries, C.G. de, 1990. "The tail index of exchange rate returns," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3108722, Tilburg University.
  7. Xiongwei Ju & Neil D. Pearson, 1998. "Using Value-at-Risk to Control Risk Taking: How Wrong Can you Be?," Finance 9810002, EconWPA.
  8. Gregory P. Hopper, 1996. "Value at risk: a new methodology for measuring portfolio risk," Business Review, Federal Reserve Bank of Philadelphia, issue Jul, pages 19-31.
  9. Samuelson, Paul A., 1967. "Efficient Portfolio Selection for Pareto-Lévy Investments," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 2(02), pages 107-122, June.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Cornelis A. Los, 2005. "The Degree of Stability of Price Diffusion," Finance 0508006, EconWPA.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpfi:0412014. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.