Pitfalls and Opportunities in the Use of Extreme Value Theory in Risk Management

Francis Diebold, Til Schuermann and John D. Stroughair

Center for Financial Institutions Working Papers from Wharton School Center for Financial Institutions, University of Pennsylvania

Abstract: Recent literature has trumpeted the claim that extreme value theory (EVT) holds promise for accurate estimation of extreme quantiles and tail probabilities of financial asset returns, and hence holds promise for advances in the management of extreme financial risks. Our view, based on a disinterested assessment of EVT from the vantage point of financial risk management, is that the recent optimism is partly appropriate but also partly exaggerated, and that at any rate much of the potential of EVT remains latent. We substantiate this claim by sketching a number of pitfalls associated with use of EVT techniques. More constructively, we show how certain of the pitfalls can be avoided, and we sketch a number of explicit research directions that will help the potential of EVT to be realized.

Date: 1998-04
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Related works:
Journal Article: Pitfalls and Opportunities in the Use of Extreme Value Theory in Risk Management (2000)
Working Paper: Pitfalls and Opportunities in the Use of Extreme Value Theory in Risk Management (1998)
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