Abstract

http://ssrn.com/abstract=1734950
 
 

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Long Term Skewness and Systemic Risk


Robert F. Engle


New York University - Leonard N. Stern School of Business - Department of Economics; New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

December 4, 2010


Abstract:     
Financial risk management has generally focused on short term risks rather than long term risks and arguably this was an important component of the recent financial crisis. Econometric approaches to measuring long term risk are developed in order to estimate the term structure of VaR and ES. Long term negative skewness increases the downside risk and is a consequence of asymmetric volatility models. A test is developed for long term skewness. In a Merton style structural default model, bankruptcies are accompanied by substantial drops in equity prices. Thus skewness in a market factor implies high defaults and default correlations even far in the future corroborating the systemic importance of long term skewness. Investors concerned about long term risks may hedge exposure as in the ICAPM. As a consequence, the aggregate wealth portfolio should have asymmetric volatility and hedge portfolios should have reversed asymmetric volatility. Using estimates from VLAB, reversed asymmetric volatility is found for many possible hedge portfolios such as volatility products, long and short term treasuries, some exchange rates and gold.

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Date posted: January 5, 2011  

Suggested Citation

Engle, Robert F., Long Term Skewness and Systemic Risk (December 4, 2010). Available at SSRN: http://ssrn.com/abstract=1734950

Contact Information

Robert F. Engle (Contact Author)
New York University - Leonard N. Stern School of Business - Department of Economics ( email )
269 Mercer Street
New York, NY 10003
United States
New York University (NYU) - Department of Finance
Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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