Financial Risk Measurement for Financial Risk Management
Torben G. Andersen
Northwestern University - Kellogg School of Management; National Bureau of Economic Research (NBER); University of Aarhus - CREATES
Duke University - Finance; Duke University - Department of Economics; National Bureau of Economic Research (NBER)
University of Toronto - Rotman School of Management; Copenhagen Business School; University of Aarhus - CREATES
Francis X. Diebold
University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)
November 2, 2011
PIER Working Paper No. 11-037
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.
Number of Pages in PDF File: 130
Keywords: Market risk, volatility, GARCH
JEL Classification: C1, G1
Date posted: November 7, 2011
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