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Extreme Risk Analysis
Extreme Risk Analysis
Extreme Risk Analysis
The stand-alone volatility and the correlation of the asset with the portfolio
contribute to the portfolios risk. Thinking in this way may help manage the
portfolio risk.
X-Sigma-Rho Risk Attribution (II)
p p
p m p m p m m
m
m m
x x x MCR
x x
o
o
o o
cE c
E = = =
, p m m m p
x o o =
The stand-alone volatility and the correlation of the asset with the portfolio
contribute to the portfolios risk. Thinking in this way may help manage the
portfolio risk.
Generalizing X-Sigma-Rho Risk
Attribution
p m m
m
x MCR
E
E =
MCR
m m m
E E
= E
p m m m
m
x
E
E = E
>
=
>
[ | VaR]
1
| VaR [ ]
m P
m
P
ES
P
E L L
E L L
>
s s
>
1 1
if L is symmetric
m
ES
s s
The marginal contribution to risk can do a
lot!
Example 3: Portfolio Insurance
ETF on the MSCI
Broad Market, spot
price $60
Put option to insure
against large losses,
strike $50
Volatility gives a very
different picture of
risk than ES
Example 3: Portfolio Insurance
On bad portfolio days, the
option has negative loss
Example 4: Coincidental Losses
Two identical portfolios joined by a copula.
In the first case, the portfolios are joined by a Gaussian copula.
In the second case, the portfolios are joined by a t-copula
The point is that in the second case, were modeling a higher probability of
coincidental losses, and the x-sigma-rho decomposition is going to show it.