Coherent Asset Allocation and Diversification in the Presence of Stress Events

Riccardo Rebonato and Alexander Denev

MPRA Paper from University Library of Munich, Germany

Abstract: We propose a method to integrate frequentist and subjective probabilities in order to obtain a coherent asset allocation in the presence of stress events. Our working assumption is that in normal market asset returns are sufficiently regular for frequentist statistical techniques to identify their joint distribution, once the outliers have been removed from the data set. We also argue, however, that the exceptional events facing the portfolio manager at any point in time are specific to the each individual crisis, and that past regularities cannot be relied upon. We therefore deal with exceptional returns by eliciting subjective probabilities, and by employing the Bayesian net technology to ensure logical consistency. The portfolio allocation is then obtained by utility maximization over the combined (normal plus exceptional) distribution of returns. We show the procedure in detail in a stylized case.

Keywords: Stress tests; asset allocation; Bayesian Networks (search for similar items in EconPapers)
JEL-codes: G11 (search for similar items in EconPapers)
Date: 2011-04-27
References: Add references at CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://mpra.ub.uni-muenchen.de/30534/1/MPRA_paper_30534.pdf original version (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:30534

Access Statistics for this paper

More papers in MPRA Paper from University Library of Munich, Germany Ludwigstraße 33, D-80539 Munich, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Joachim Winter ().