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Pitfalls and Opportunities in the Use of Extreme Value Theory in Risk Management

13 Pages Posted: 11 Nov 2008  

Francis X. Diebold

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Til Schuermann

Oliver Wyman

John Stroughair

Oliver, Wyman & Company, LLC.

Date Written: March 1998

Abstract

Recent literature has trumpeted the claim that extreme value theory (EVT) holds promise for accurate estimation of extreme quantiles and tail probabilities of financial asset returns, and hence hold promise for advances in the management of extreme financial risks. Our view, based on a disinterested assessment of EVT from the vantage point of financial risk management, is that the recent optimism is partly appropriate but also partly exaggerated, and that at any rate much of the potential of EVT remains latent. We substantiate this claim by sketching a number of pitfalls associate with use of EVT techniques. More constructively, we show how certain of the pitfalls can be avoided, and we sketch a number of explicit research directions that will help the potential of EVT to be realized.

Suggested Citation

Diebold, Francis X. and Schuermann, Til and Stroughair, John, Pitfalls and Opportunities in the Use of Extreme Value Theory in Risk Management (March 1998). NYU Working Paper No. FIN-98-081. Available at SSRN: https://ssrn.com/abstract=1298286

Francis X. Diebold (Contact Author)

University of Pennsylvania - Department of Economics ( email )

160 McNeil Building
3718 Locust Walk
Philadelphia, PA 19104
United States
215-898-1507 (Phone)
215-573-4217 (Fax)

HOME PAGE: http://www.ssc.upenn.edu/~fdiebold/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Til Schuermann

Oliver Wyman ( email )

1166 6th Avenue
New York City, NY
United States

John Stroughair

Oliver, Wyman & Company, LLC.

666 Fifth Ave.
New York, NY 10103
United States

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