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Long-Term Skewness and Systemic Risk

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  • Robert F. Engle

Abstract

Financial risk management has generally focused on short-term risks rather than long-term risks, and arguably this was an important component of the recent financial crisis. Econometric approaches to measuring long-term risk are developed in order to estimate the term structure of value at risk and expected shortfall. Long-term negative skewness increases the downside risk and is a consequence of asymmetric volatility models. A test is developed for long-term skewness. In a Merton style structural default model, bankruptcies are accompanied by substantial drops in equity prices. Thus, skewness in a market factor implies high defaults and default correlations even far in the future corroborating the systemic importance of long-term skewness. Investors concerned about long-term risks may hedge exposure as in the Intertemporal Capital Asset Pricing Model (ICAPM). As a consequence, the aggregate wealth portfolio should have asymmetric volatility and hedge portfolios should have reversed asymmetric volatility. Using estimates from VLAB, reversed asymmetric volatility is found for many possible hedge portfolios such as volatility products, long- and short-term treasuries, some exchange rates, and gold. JEL: G01 Copyright The Author 2011. Published by Oxford University Press. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Suggested Citation

  • Robert F. Engle, 2011. "Long-Term Skewness and Systemic Risk," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 9(3), pages 437-468, Summer.
  • Handle: RePEc:oup:jfinec:v:9:y:2011:i:3:p:437-468
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    File URL: http://hdl.handle.net/10.1093/jjfinec/nbr002
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    Citations

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    Cited by:

    1. Johannes Rauch & Carol Alexander, 2016. "Tail Risk Premia for Long-Term Equity Investors," Papers 1602.00865, arXiv.org.
    2. CARPANTIER, Jean - François, 2010. "Commodities inventory effect," CORE Discussion Papers 2010040, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    3. Juneja, Januj A., 2016. "Financial crises and estimation bias in international bond markets," Research in International Business and Finance, Elsevier, vol. 38(C), pages 593-607.
    4. BAUWENS, Luc & HAFNER, Christian & LAURENT, Sébastien, 2011. "Volatility models," CORE Discussion Papers 2011058, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    5. Chabi-Yo, Fousseni & Leisen, Dietmar P.J. & Renault, Eric, 2014. "Aggregation of preferences for skewed asset returns," Journal of Economic Theory, Elsevier, vol. 154(C), pages 453-489.
    6. Behmiri, Niaz Bashiri & Manera, Matteo, 2015. "The role of outliers and oil price shocks on volatility of metal prices," Resources Policy, Elsevier, vol. 46(P2), pages 139-150.
    7. repec:rsr:supplm:v:65:y:2017:i:6:p:174-183 is not listed on IDEAS
    8. repec:iez:survey:ces-v19_1-2017_palic-posedelsimovic-vizek is not listed on IDEAS
    9. Andersen, Torben G. & Bollerslev, Tim & Christoffersen, Peter F. & Diebold, Francis X., 2013. "Financial Risk Measurement for Financial Risk Management," Handbook of the Economics of Finance, Elsevier.
    10. M. Angeles Carnero Fernández & Ana Pérez Espartero, 2018. "Outliers and misleading leverage effect in asymmetric GARCH-type models," Working Papers. Serie AD 2018-01, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    11. repec:eee:finlet:v:23:y:2017:i:c:p:202-209 is not listed on IDEAS
    12. CARPANTIER, Jean-François & DUFAYS, Arnaud, 2012. "Commodities volatility and the theory of storage," CORE Discussion Papers 2012037, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    13. repec:bor:bistre:v:17:y:2017:i:1:p:25-48 is not listed on IDEAS
    14. Renault, Eric & van der Heijden, Thijs & Werker, Bas J.M., 2014. "The dynamic mixed hitting-time model for multiple transaction prices and times," Journal of Econometrics, Elsevier, vol. 180(2), pages 233-250.
    15. Engle, Robert & Mistry, Abhishek, 2014. "Priced risk and asymmetric volatility in the cross section of skewness," Journal of Econometrics, Elsevier, vol. 182(1), pages 135-144.
    16. María José Rodríguez & Esther Ruiz, 2012. "Revisiting Several Popular GARCH Models with Leverage Effect: Differences and Similarities," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 10(4), pages 637-668, September.
    17. repec:rsr:supplm:v:65:y:2017:i:5:p:221-229 is not listed on IDEAS

    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises

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