New Extreme-Value Dependence Measures and Finance Applications

Abstract:     
In the finance literature, cross-sectional dependence in extreme returns of risky assets is often modelled implicitly assuming an asymptotically dependent structure. If the true dependence structure is asymptotically independent then existing finance models will lead to over-estimation of the risk of simultaneous extreme events. We provide simple techniques for deciding between these dependence classes and for quantifying the degree of dependence in each class. Examples based on daily stock market returns show that there is strong evidence in favour of asymptotically independent models for dependence in extremal stock market returns, and that most of the extremal dependence is due to heteroskedasticity in stock returns processes.

Number of Pages in PDF File: 33

Keywords: Asymptotic independence, extreme value theory, Hill's estimator, tail index

JEL Classification: C13, C22, G11, G15

working papers series