A New Measure of Cross-Sectional Risk and its Empirical Implications for Portfolio Risk Management

43 Pages Posted: 2 Mar 2005 Last revised: 12 Nov 2015

See all articles by Andrea Roncoroni

Andrea Roncoroni

ESSEC Business School

Stefano Galluccio

BNP Paribas Fixed Income

Abstract

Litterman, Scheinkman, and Weiss (1991) and Engle and Ng (1993) provide empirical evidence of a relation between yield curve shape and volatility. This study offers theoretical support for that finding in the general context of cross-sectional time series. We introduce a new risk measure quantifying the link between cross-sectional shape and market risk. A simple econometric procedure allows us to represent the risk experienced by cross-sections over a time period in terms of independent factors reproducing possible cross-sectional deformations. We compare our risk measure to the traditional cross-yield covariance according to their relative performance. Empirical investigation in the US interest rate market shows that 1) cross-shape risk factors outperform cross-yield risk factors (i.e., yield curve level, slope, and convexity) in explaining the market risk of yield curve dynamics; 2) hedging multiple liabilities against cross-shape risk delivers superior trading strategies compared to those stemming from cross-yield risk management.

Keywords: Risk Measures, Risk Management, Factor Analysis, Cross-Sections, Interest Rates

JEL Classification: C31, E43, G11

Suggested Citation

Roncoroni, Andrea and Galluccio, Stefano, A New Measure of Cross-Sectional Risk and its Empirical Implications for Portfolio Risk Management. EFA 2005 Moscow Meetings Paper, Journal of Banking and Finance, Vol. 30, No. 8, 2006, Available at SSRN: https://ssrn.com/abstract=675993 or http://dx.doi.org/10.2139/ssrn.675993

Andrea Roncoroni (Contact Author)

ESSEC Business School ( email )

Avenue Bernard Hirsch BP 50105
Cergy-Pontoise, 95021
France
+33 (0)1 34 43 32 39 (Phone)
+33 (0)1 34 43 30 01 (Fax)

HOME PAGE: http://www45.essec.edu/faculty/andrea-roncoroni

Stefano Galluccio

BNP Paribas Fixed Income ( email )

10, Harewood Avenue
NW1 6AA London
United Kingdom

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