Expected Shortfall and Portfolio Management in Contagious Markets

36 Pages Posted: 8 Mar 2018

See all articles by Alice Buccioli

Alice Buccioli

Department of Economics and Business Economics, Aarhus BSS

Thomas Kokholm

School of Business and Social Sciences, Aarhus University

Marco Nicolosi

University of Perugia - Department of Economics

Date Written: March 8, 2018

Abstract

We study the impact of market contagion on portfolio management. To model possible recurrence in the arrival of extreme events, we equip classic Poisson jumps with long memory via past-weighted randomization of the likelihood of their occurrences (Hawkes processes). Within this framework, we tackle the problem of optimal portfolio selection in terms of Expected Shortfall (ES). We use the generalized method of moments to estimate the model on three US stock indexes, representing three major sectors of the US economy. The moment conditions of the model are computed efficiently in closed form applying a novel technique. Given parameter estimates, we minimize, at a monthly frequency in the period 2001-2016, the ES of a portfolio consisting of the three US sector indexes. We find that the weights of the optimal portfolio are significantly adjusted when the level of contagion is high. Finally, we perform an extensive out-of-sample back-test and find that the Hawkes jump-diffusion model outperforms two traditional models that are commonly implemented.

Keywords: Hawkes Process, Contagion, Expected Shortfall, Back-Testing, Portfolio Management

JEL Classification: G11, G18, G32

Suggested Citation

Buccioli, Alice and Kokholm, Thomas and Nicolosi, Marco, Expected Shortfall and Portfolio Management in Contagious Markets (March 8, 2018). Available at SSRN: https://ssrn.com/abstract=3136402 or http://dx.doi.org/10.2139/ssrn.3136402

Alice Buccioli

Department of Economics and Business Economics, Aarhus BSS ( email )

Fuglesangs Allé 4
Aarhus V, 8210
Denmark

Thomas Kokholm (Contact Author)

School of Business and Social Sciences, Aarhus University ( email )

Fuglesangs Allé 4
Aarhus, DK-8210
Denmark

Marco Nicolosi

University of Perugia - Department of Economics ( email )

via Pascoli, 20
PG 06123 Perugia, 06123
Italy

Register to save articles to
your library

Register

Paper statistics

Downloads
60
Abstract Views
340
rank
354,695
PlumX Metrics