Long-Term Asset Tail Risk in Developed and Emerging Markets
32 Pages Posted: 15 Mar 2012
Date Written: March 12, 2012
The tail of financial returns is typically governed by a power law (i.e. “fat tails”). However, the constancy of the so-called tail index α which dictates the tail decay has been hardly investigated. We study the finite sample properties of some recently proposed endogenous tests for structural change in α. Given that the finite sample critical values strongly depend on the tail parameters of the return distribution we propose a bootstrap-based version of the structural change test. Our empirical application spans a wide variety of long-term developed and emerging financial asset returns. Somewhat surprisingly, the tail behavior of emerging stock markets is not more strongly inclined to structural change than their developed counterparts. Emerging currencies, on the contrary, are more prone to shifts in the tail behavior than developed currencies. Our results suggest that extreme value theory (EVT) applications in hedging tail risks or in assessing the (changing) propensity to financial crises can assume stationary tail behavior over long time spans provided one considers portfolios that solely consist of stocks or bonds. However, our break results also indicate it is advisable to use shorter estimation windows when applying EVT methods to emerging currency portfolios.
Keywords: Tail Index, Extreme Value Analysis, Endogenous Stability Test, Finite Sample Properties, Bootstrap
JEL Classification: F31, G15, G19, C49
Suggested Citation: Suggested Citation