The Extreme Value Theory as a Tool to Measure Market Risk
Krenar Avdulaj ()
No 2011/26, Working Papers IES from Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies
Assessing the extreme events is crucial in financial risk management. All risk managers and financial institutions want to know the risk of their portfolio under rare events scenarios. We illustrate a multivariate market risk estimating method which employs Monte Carlo simulations to estimate Value-at-Risk (VaR) for a portfolio of 4 stock exchange indexes from Central Europe. The method uses the non-parametric empirical distribution to capture small risks and the parametric Extreme Value theory to capture large and rare risks. We compare estimates of this method with historical simulation and variance-covariance method under low and high volatility samples of data. In general historical simulation method overestimates the VaR for extreme events, while variance-covariance underestimates it. The method that we illustrate gives a result in between because it considers historical performance of the stocks and also corrects for the heavy tails of the distribution. We conclude that the estimate method that we illustrate here is useful in estimating VaR for extreme events, especially for high volatility times.
Keywords: Value-at-Risk; Extreme Value Theory; copula. (search for similar items in EconPapers)
JEL-codes: C22 G17 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-ecm and nep-rmg
Date: 2011-07, Revised 2011-07
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Persistent link: https://EconPapers.repec.org/RePEc:fau:wpaper:wp2011_26
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