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Dependence structure of risk factors and diversification effects

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  • Chen Zou

Abstract

In this paper, we study the aggregated risk from dependent risk factors under the multivariate Extreme Value theory (EVT) framework. We consider the heavy-tailness of the risk factors as well a non-parametric tail dependence structure. This allows a large scope of models on the dependency. We assess the Value-at-Risk of a diversified portfolio constructed from dependent risk factors. Moreover, we examine the diversification effects under this setup.

Suggested Citation

  • Chen Zou, 2009. "Dependence structure of risk factors and diversification effects," DNB Working Papers 219, Netherlands Central Bank, Research Department.
  • Handle: RePEc:dnb:dnbwpp:219
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    File URL: https://www.dnb.nl/binaries/Working%20Paper%20219-2009_tcm46-220795.pdf
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    References listed on IDEAS

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    1. P. Hartmann & S. Straetmans & C. G. de Vries, 2004. "Asset Market Linkages in Crisis Periods," The Review of Economics and Statistics, MIT Press, vol. 86(1), pages 313-326, February.
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    4. Rustam Ibragimov & Johan Walden, 2006. "Portfolio Diversification Under Local, Moderate and Global Deviations From Power Laws," Harvard Institute of Economic Research Working Papers 2116, Harvard - Institute of Economic Research.
    5. Namwon Hyung, 2005. "Portfolio Diversification Effects of Downside Risk," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 3(1), pages 107-125.
    6. Susmel, Raul, 2001. "Extreme observations and diversification in Latin American emerging equity markets," Journal of International Money and Finance, Elsevier, vol. 20(7), pages 971-986, December.
    7. Jansen, Dennis W & de Vries, Casper G, 1991. "On the Frequency of Large Stock Returns: Putting Booms and Busts into Perspective," The Review of Economics and Statistics, MIT Press, vol. 73(1), pages 18-24, February.
    8. Ibragimov, Rustam & Walden, Johan, 2008. "Portfolio diversification under local and moderate deviations from power laws," Insurance: Mathematics and Economics, Elsevier, vol. 42(2), pages 594-599, April.
    9. Embrechts, Paul & Neslehová, Johanna & Wüthrich, Mario V., 2009. "Additivity properties for Value-at-Risk under Archimedean dependence and heavy-tailedness," Insurance: Mathematics and Economics, Elsevier, vol. 44(2), pages 164-169, April.
    10. W. Jansen Dennis, 2001. "Limited Downside Risk In Portfolio Selection Among U.S. and Pacific Basin Equities," International Economic Journal, Taylor & Francis Journals, vol. 15(4), pages 1-39.
    11. Jansen, Dennis W. & Koedijk, Kees G. & de Vries, Casper G., 2000. "Portfolio selection with limited downside risk," Journal of Empirical Finance, Elsevier, vol. 7(3-4), pages 247-269, November.
    12. Ser-Huang Poon, 2004. "Extreme Value Dependence in Financial Markets: Diagnostics, Models, and Financial Implications," Review of Financial Studies, Society for Financial Studies, vol. 17(2), pages 581-610.
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    14. Walden, Johan & Ibragimov, Rustam, 2008. "Portfolio Diversification under Local and Moderate Deviations from Power Laws," Scholarly Articles 2640586, Harvard University Department of Economics.
    15. Barbe, Philippe & Fougères, Anne-Laure & Genest, Christian, 2006. "On the Tail Behavior of Sums of Dependent Risks," ASTIN Bulletin: The Journal of the International Actuarial Association, Cambridge University Press, vol. 36(02), pages 361-373, November.
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    Cited by:

    1. Marco Rocco, 2011. "Extreme value theory for finance: a survey," Questioni di Economia e Finanza (Occasional Papers) 99, Bank of Italy, Economic Research and International Relations Area.
    2. Chollete, Loran & de la Pena , Victor & Lu, Ching-Chih, 2009. "International Diversification: An Extreme Value Approach," UiS Working Papers in Economics and Finance 2009/26, University of Stavanger.

    More about this item

    Keywords

    Aggregated risk; diversification effect; multivariate Extreme Value Theory;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General

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