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Point process models for extreme returns: Harnessing implied volatility

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  • R Herrera
  • Adam Clements

    () (QUT)

Abstract

Forecasting the risk of extreme losses is an important issue in the management of financial risk. There has been a great deal of research examining how option implied volatilities (IV) can be used to forecasts asset return volatility. However, the impact of IV in the context of predicting extreme risk has received relatively little attention. The role of IV is considered within a range of models beginning with the traditional GARCH based approach. Furthermore, a number of novel point process models for forecasting extreme risk are proposed in this paper. Univariate models where IV is included as an exogenous variable are considered along with a novel bivariate approach where movements in IV are treated as another point process. It is found that in the context of forecasting Value-at-Risk, the bivariate models produce the most accurate forecasts across a wide range of scenarios.

Suggested Citation

  • R Herrera & Adam Clements, 2015. "Point process models for extreme returns: Harnessing implied volatility," NCER Working Paper Series 104, National Centre for Econometric Research.
  • Handle: RePEc:qut:auncer:2015_02
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    References listed on IDEAS

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    Keywords

    Implied volatility; Hawkes process; Peaks over threshold; Point process; Extreme events;

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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