Measuring Exposure to Dependence Risk with Random Bernstein Copula Scenarios
European Journal of Operational Research, Volume 270, Issue 3, 1 November 2018, Pages 873-888
36 Pages Posted: 8 Dec 2016 Last revised: 23 Feb 2019
Date Written: July 28, 2017
This paper considers the problem of measuring the exposure to dependence risk carried by a portfolio with an arbitrary number of two-asset derivative contracts. We develop a worst-case risk measure computed over a set of dependence scenarios within a divergence restricted region. The set of dependence scenarios corresponds to Bernstein copulas obtained by simulating random doubly stochastic matrices. We then devise a method to compute hedging positions when a limited number of hedging instruments are available for trading. In an empirical study we show how the proposed method can be used to reveal an exposure to dependence risk where usual sensitivity methods fail to reveal it. We also illustrate the ability of the proposed method to generate parsimonious hedging strategies in order to reduce the exposure to dependence risk of a given portfolio.
Keywords: Risk Management, Banking, Financial Modeling, Simulation, Bernstein Copulas, Random Matrices
JEL Classification: G10, C53, D81
Suggested Citation: Suggested Citation