New Financial Economics Study Findings Have Been Reported by Scientists at New York University
Long-term negative skewness increases the downside risk and is a consequence of asymmetric volatility models.
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"Financial risk management has generally focused on short-term risks rather than long-term risks, and arguably this was an important component of the recent financial crisis. Econometric approaches to measuring long-term risk are developed in order to estimate the term structure of value at risk and expected shortfall," scientists in New York City, New York report.
"Long-term negative skewness increases the downside risk and is a consequence of asymmetric volatility models. A test is developed for long-term skewness. In a Merton style structural default model, bankruptcies are accompanied by substantial drops in equity prices. Thus, skewness in a market factor implies high defaults and default correlations even far in the future corroborating the systemic importance of long-term skewness. Investors concerned about long-term risks may hedge exposure as in the Intertemporal Capital Asset Pricing Model (ICAPM). As a consequence, the aggregate wealth portfolio should have asymmetric volatility and hedge portfolios should have reversed asymmetric volatility," wrote R.F. Engle and colleagues, New York University.
The researchers concluded: "Using estimates from VLAB, reversed asymmetric volatility is found for many possible hedge portfolios such as volatility products, long- and short-term treasuries, some exchange rates, and gold."
Engle and colleagues published their study in the Journal of Financial Econometrics (Long-Term Skewness and Systemic Risk. Journal of Financial Econometrics, 2011;9(3):437-468).
For additional information, contact R.F. Engle, New York University, Stern School Business, 44 W 4th St., New York City, NY 10012, United States.
The publisher's contact information for the Journal of Financial Econometrics is: Oxford University Press, Great Clarendon St., Oxford OX2 6DP, England.
This article was prepared by Economics Week editors from staff and other reports. Copyright 2011, Economics Week via VerticalNews.com.