Arbeitspapier

Correlation Under Stress In Normal Variance Mixture Models

We investigate correlations of asset returns in stress scenarios where a common risk factor is truncated. Our analysis is performed in the class of normal variance mixture (NVM) models, which encompasses many distributions commonly used in nancial modelling. For the special cases of jointly normally and t-distributed asset returns we derive closed formulas for the correlation under stress. For the NVM distribution, we calculate the asymptotic limit of the correlation under stress, which depends on whether the variables are in the maximum domain of attraction of the Frechet or Gumbel distribution. It turns out that correlations in heavy-tailed NVM models are less sensitive to stress than in medium- or light-tailed models. Our analysis sheds light on the suitability of this model class to serve as a quantitative framework for stress testing, and as such provides valuable information for risk and capital management in nancial institutions, where NVM models are frequently used for assessing capital adequacy. We also demonstrate how our results can be applied for more prudent stress testing.

Language
Englisch

Bibliographic citation
Series: IRTG 1792 Discussion Paper ; No. 2018-035

Classification
Wirtschaft
Mathematical and Quantitative Methods: General
Subject
Stress testing
risk management
correlation
normal variance mixture distribution
multivariate normal distribution
multivariate t-distribution

Event
Geistige Schöpfung
(who)
Kalkbrener, Michael
Packham, Natalie
Event
Veröffentlichung
(who)
Humboldt-Universität zu Berlin, International Research Training Group 1792 "High Dimensional Nonstationary Time Series"
(where)
Berlin
(when)
2018

Handle
Last update
10.03.2025, 11:43 AM CET

Data provider

This object is provided by:
ZBW - Deutsche Zentralbibliothek für Wirtschaftswissenschaften - Leibniz-Informationszentrum Wirtschaft. If you have any questions about the object, please contact the data provider.

Object type

  • Arbeitspapier

Associated

  • Kalkbrener, Michael
  • Packham, Natalie
  • Humboldt-Universität zu Berlin, International Research Training Group 1792 "High Dimensional Nonstationary Time Series"

Time of origin

  • 2018

Other Objects (12)