Measuring financial risk and portfolio optimization with a non-Gaussian multivariate model

Young Shin Kim, Rosella Giacometti, Svetlozar T. Rachev, Frank Fabozzi () and Domenico Mignacca

No 44, Working Paper Series in Economics from Karlsruhe Institute of Technology (KIT), Department of Economics and Management

Abstract: In this paper, we propose a multivariate market model with returns assumed to follow a multivariate normal tempered stable distribution. This distribution, defined by a mixture of the multivariate normal distribution and the tempered stable subordinator, is consistent with two stylized facts that have been observed for asset distributions: fat-tails and an asymmetric dependence structure. Assuming infinitely divisible distributions, we derive closed-form solutions for two important measures used by portfolio managers in portfolio construction: the marginal VaR and the marginal AVaR. We illustrate the proposed model using stocks comprising the Dow Jones Industrial Average, first statistically validating the model based on goodness-of-fit tests and then demonstrating how the marginal VaR and marginal AVaR can be used for portfolio optimization using the model. Based on the empirical evidence presented in this paper, our framework offers more realistic portfolio risk measures and a more tractable method for portfolio optimization.

Keywords: portfolio risk; portfolio optimization; portfolio budgeting; marginal contribution; fat-tailed distribution; multivariate normal tempered stable distribution (search for similar items in EconPapers)
JEL-codes: C58 C61 G11 G32 (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-ecm and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (35)

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Journal Article: Measuring financial risk and portfolio optimization with a non-Gaussian multivariate model (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:kitwps:44

DOI: 10.5445/IR/1000029307

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