Working Paper: NBER ID: w18084
Authors: Torben G. Andersen; Tim Bollerslev; Peter F. Christoffersen; Francis X. Diebold
Abstract: Current practice largely follows restrictive approaches to market risk measurement, such as historical simulation or RiskMetrics. In contrast, we propose flexible methods that exploit recent developments in financial econometrics and are likely to produce more accurate risk assessments, treating both portfolio-level and asset-level analysis. Asset-level analysis is particularly challenging because the demands of real-world risk management in financial institutions - in particular, real-time risk tracking in very high-dimensional situations - impose strict limits on model complexity. Hence we stress powerful yet parsimonious models that are easily estimated. In addition, we emphasize the need for deeper understanding of the links between market risk and macroeconomic fundamentals, focusing primarily on links among equity return volatilities, real growth, and real growth volatilities. Throughout, we strive not only to deepen our scientific understanding of market risk, but also cross-fertilize the academic and practitioner communities, promoting improved market risk measurement technologies that draw on the best of both.
Keywords: Financial Risk Measurement; Risk Management; Econometrics
JEL Codes: C1; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| traditional methods such as historical simulation (C51) | inaccurate risk assessments (D91) |
| proposed econometric models (GARCH and realized volatility) (C58) | improved risk measurement (C58) |
| improved risk measurement (C58) | better risk management practices (G38) |
| better risk management practices (G38) | mitigate financial losses during periods of high volatility (G17) |
| market risk (G17) | variations in equity return volatilities (G17) |
| real growth rates (O49) | variations in equity return volatilities (G17) |
| real growth rates volatilities (O49) | variations in equity return volatilities (G17) |