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Orthogonal Methods for Generating Large Positive Semi-Definite Covariance Matrices

Carol Alexander ()

ICMA Centre Discussion Papers in Finance from Henley Business School, University of Reading

Abstract: It is a common problem in risk management today that risk measures and pricing models are being applied to a very large set of scenarios based on movements in all possible risk factors. The dimensions are so large that the computations become extremely slow and cumbersome, so it is quite common that over-simplistic assumptions will be made. In particular, in order to generate the large covariance matrices that are used in Value-at-Risk models, some very strong constraints are imposed on the movements in volatility and correlations in all the standard models. The constant volatility assumption is also imposed, because it has not been possible to generate large GARCH covariance matrices with mean-reverting term structures.

Pages: 23 pages
Date: 2000
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