Stochastic Volatilities and Correlations, Extreme Values and Modeling the Macroeconomic Environment, Under Which Brazilian Banks Operate

54 Pages Posted: 27 Dec 2007

See all articles by Theodore Barnhill

Theodore Barnhill

George Washington University - Department of Finance

Marcos Souto

George Washington University - School of Business; International Monetary Fund (IMF)

Date Written: December 2007

Abstract

Using monthly data for a set of variables, we examine the out-of-sample performance of various variance/covariance models and find that no model has consistently outperformed the others. We also show that it is possible to increase the probability mass toward the tails and to match reasonably well the historical evolution of volatilities by changing a decay factor appropriately. Finally, we implement a simple stochastic volatility model and simulate the credit transition matrix for two large Brazilian banks and show that this methodology has the potential to improve simulated transition probabilities as compared to the constant volatility case. In particular, it can shift CTM probabilities towards lower credit risk categories.

Keywords: Emerging markets, Brazil, Banks, Interest rates, Credit risk

Suggested Citation

Barnhill, Theodore and Souto, Marcos, Stochastic Volatilities and Correlations, Extreme Values and Modeling the Macroeconomic Environment, Under Which Brazilian Banks Operate (December 2007). Available at SSRN: https://ssrn.com/abstract=1078795 or http://dx.doi.org/10.2139/ssrn.1078795

Theodore Barnhill

George Washington University - Department of Finance ( email )

2023 G Street
Washington, DC 20052
United States

Marcos Souto

George Washington University - School of Business ( email )

Washington, DC 20052
United States

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

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