Final published version
Research output: Contribution to Journal/Magazine › Journal article › peer-review
Research output: Contribution to Journal/Magazine › Journal article › peer-review
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TY - JOUR
T1 - Hedging the Black Swan
T2 - conditional heteroscedasticity and tail dependence in S&P500 and VIX
AU - Abbas, Sawsan
AU - Poon, Ser-Huang
AU - Tawn, Jonathan Angus
PY - 2011/9
Y1 - 2011/9
N2 - The recent financial crisis has accentuated the fact that extreme outcomes have been overlooked and not dealt with adequately. While extreme value theories have existed for a long time, the multivariate variant is difficult to handle in the financial markets due to the prevalent heteroskedasticity embedded in most financial time series, and the complex extremal dependence that cannot be conveniently captured by a single structure. Moreover, most of the existing approaches are based on a limiting argument in which all variables become large at the same rate. In this paper, we show how the conditional approach of Heffernan and Tawn (2004) can be implemented to model extremal dependence between financial time series. We use a hedging example based on VIX futures to demonstrate the flexibility and superiority of the conditional approach against the conventional OLS regression approach.
AB - The recent financial crisis has accentuated the fact that extreme outcomes have been overlooked and not dealt with adequately. While extreme value theories have existed for a long time, the multivariate variant is difficult to handle in the financial markets due to the prevalent heteroskedasticity embedded in most financial time series, and the complex extremal dependence that cannot be conveniently captured by a single structure. Moreover, most of the existing approaches are based on a limiting argument in which all variables become large at the same rate. In this paper, we show how the conditional approach of Heffernan and Tawn (2004) can be implemented to model extremal dependence between financial time series. We use a hedging example based on VIX futures to demonstrate the flexibility and superiority of the conditional approach against the conventional OLS regression approach.
KW - Financial time series
KW - Extreme value theory
KW - Extremal dependence structure
KW - Downside risk
KW - Optimal hedge ratio
U2 - 10.1016/j.jbankfin.2011.01.035
DO - 10.1016/j.jbankfin.2011.01.035
M3 - Journal article
VL - 35
SP - 2374
EP - 2387
JO - Journal of Banking and Finance
JF - Journal of Banking and Finance
SN - 0378-4266
IS - 9
ER -