Related papers: Correlation scenarios and correlation stress testi…
The instability of historical risk factor correlations renders their use in estimating portfolio risk extremely questionable. In periods of market stress correlations of risk factors have a tendency to quickly go well beyond estimated…
In 2012, JPMorgan accumulated a USD~6.2 billion loss on a credit derivatives portfolio, the so-called `London Whale', partly as a consequence of de-correlations of non-perfectly correlated positions that were supposed to hedge each other.…
This paper proposes a formal framework for reverse stress testing geopolitical risk in corporate credit portfolios. A joint macro-financial scenario vector, augmented with an explicit geopolitical risk factor, is mapped into stressed…
This note outlines an approach to stress testing of covariance of financial time series, in the context of financial risk management. It discusses how the geodesic distance between covariance matrices implies a notion of plausibility of…
Stress testing refers to the application of adverse financial or macroeconomic scenarios to a portfolio. For this purpose, financial or macroeconomic risk factors are linked with asset returns, typically via a factor model. We expand the…
The most recent financial upheavals have cast doubt on the adequacy of some of the conventional quantitative risk management strategies, such as VaR (Value at Risk), in many common situations. Consequently, there has been an increasing need…
A new methodology has been introduced to clean the correlation matrix of single stocks returns based on a constrained principal component analysis using financial data. Portfolios were introduced, namely "Fundamental Maximum Variance…
Estimating time-varying correlation matrices is challenging because existing methods may adapt slowly to structural changes, impose insufficient regularization, or produce diffuse posterior uncertainty. In moderate dimensions, an additional…
In this paper, we are interested in evaluating the resilience of financial portfolios under extreme economic conditions. Therefore, we use empirical measures to characterize the transmission process of macroeconomic shocks to risk…
As an important tool in financial risk management, stress testing aims to evaluate the stability of financial portfolios under some potential large shocks from extreme yet plausible scenarios of risk factors. The effectiveness of a stress…
We discuss some methods to quantitatively investigate the properties of correlation matrices. Correlation matrices play an important role in portfolio optimization and in several other quantitative descriptions of asset price dynamics in…
Value at Risk (VaR) and stress testing are two of the most widely used approaches in portfolio risk management to estimate potential market value losses under adverse market moves. VaR quantifies potential loss in value over a specified…
Estimation of the covariance matrix of asset returns is crucial to portfolio construction. As suggested by economic theories, the correlation structure among assets differs between emerging markets and developed countries. It is therefore…
We discuss a weighted estimation of correlation and covariance matrices from historical financial data. To this end, we introduce a weighting scheme that accounts for similarity of previous market conditions to the present one. The…
The multivariate conditional probability distribution models the effects of a set of variables onto the statistical properties of another set of variables. In the study of systemic risk in a financial system, the multivariate conditional…
Building a machine learning solution in real-life applications often involves the decomposition of the problem into multiple models of various complexity. This has advantages in terms of overall performance, better interpretability of the…
We analyze correlations among stock returns via a series of widely adopted parameters which we refer to as explanatory variables. We subsequently exploit the results to propose a long only quantitative adaptive technique to construct a…
Credit risk stress testing has become an important risk management device which is used both by banks internally and by regulators. Stress testing is complex because it essentially means projecting a bank's full balance sheet conditional on…
Stress testing, and in particular, reverse stress testing, is a prominent exercise in risk management practice. Reverse stress testing, in contrast to (forward) stress testing, aims to find an alternative but plausible model such that under…
Financial correlations play a central role in financial theory and also in many practical applications. From theoretical point of view, the key interest is in a proper description of the structure and dynamics of correlations. From…