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Practical Volatility and Correlation Modeling for Financial Market Risk Management

In: The Risks of Financial Institutions

  • Torben G. Andersen
  • Tim Bollerslev
  • Peter Christoffersen
  • Francis X. Diebold

What do academics have to offer market risk management practitioners in financial institutions? Current industry practice largely follows one of two extremely restrictive approaches: historical simulation or RiskMetrics. In contrast, we favor flexible methods based on recent developments in financial econometrics, which are likely to produce more accurate assessments of market risk. Clearly, the demands of real-world risk management in financial institutions -- in particular, real-time risk tracking in very high-dimensional situations -- impose strict limits on model complexity. Hence we stress parsimonious models that are easily estimated, and we discuss a variety of practical approaches for high-dimensional covariance matrix modeling, along with what we see as some of the pitfalls and problems in current practice. In so doing we hope to encourage further dialog between the academic and practitioner communities, hopefully stimulating the development of improved market risk management technologies that draw on the best of both worlds.

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This chapter was published in:
  • Mark Carey & René M. Stulz, 2007. "The Risks of Financial Institutions," NBER Books, National Bureau of Economic Research, Inc, number care06-1, May.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 9618.
    Handle: RePEc:nbr:nberch:9618
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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