Managing Adverse Dependence for Portfolios of Collateral in Financial Infrastructures

Bank of Canada Working Paper No. 2007-25

31 Pages Posted: 15 Apr 2007

Date Written: April 2007

Abstract

We propose a framework that allows a portfolio manager to quantify the probability of simultaneous losses in multiple assets of a collateral portfolio. Using this framework, we propose a methodology to conduct stress tests on the market value of the portfolio of collateral when undesirable extreme dependence occurs. This framework permits us to quantify the potential impact on the portfolio returns of systemic events that change, or 'break down', the historical comovement structure, imposing an adverse extreme dependence. We illustrate our framework using securities pledged as collateral in the Canadian securities clearing and settlement system.

Keywords: Collateral under extreme events, Copulas, Frechet bounds, Financial risk management, Extreme value theory

JEL Classification: G00, G10, C10

Suggested Citation

Garcia, Alejandro and Gencay, Ramazan, Managing Adverse Dependence for Portfolios of Collateral in Financial Infrastructures (April 2007). Bank of Canada Working Paper No. 2007-25, Available at SSRN: https://ssrn.com/abstract=980255 or http://dx.doi.org/10.2139/ssrn.980255

Alejandro Garcia (Contact Author)

Bank of Canada ( email )

234 Wellington St.
Ottawa, Ontario K1A 0G9
Canada

Ramazan Gencay

Simon Fraser University ( email )

Department of Economics
8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

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