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Portfolio selection: An extreme value approach

Francis DiTraglia and Jeffrey R. Gerlach

Journal of Banking & Finance, 2013, vol. 37, issue 2, 305-323

Abstract: We show theoretically that lower tail dependence (χ), a measure of the probability that a portfolio will suffer large losses given that the market does, contains important information for risk-averse investors. We then estimate χ for a sample of DJIA stocks and show that it differs systematically from other risk measures including variance, semi-variance, skewness, kurtosis, beta, and coskewness. In out-of-sample tests, portfolios constructed to have low values of χ outperform the market index, the mean return of the stocks in our sample, and portfolios with high values of χ. Our results indicate that χ is conceptually important for risk-averse investors, differs substantially from other risk measures, and provides useful information for portfolio selection.

Keywords: Portfolio selection; Extreme value theory; Tail dependence (search for similar items in EconPapers)
JEL-codes: C58 G11 (search for similar items in EconPapers)
Date: 2013
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