Marking Systemic Portfolio Risk with Application to the Correlation Skew of Equity Baskets

Details Marking Systemic Portfolio Risk with Application to the Correlation Skew of Equity Baskets Marking Systemic Portfolio Risk with Application to the Correlation Skew of Equity Baskets

2010-12-21

arxiv.org/abs/1012.4674v4

Economy

Quantitative Finance

Risk Management

Correlation skew, Systemic Risk, Merton jump model, equity basket

Scientific paper

The downside risk of a portfolio of (equity)assets is generally substantially higher than the downside risk of its components. In particular in times of crises when assets tend to have high correlation, the understanding of this difference can be crucial in managing systemic risk of a portfolio. In this paper we generalize Merton's option formula in the presence jumps to the multi-asset case. It is shown how common jumps across assets provide an intuitive and powerful tool to describe systemic risk that is consistent with data. The methodology provides a new way to mark and risk-manage systemic risk of portfolios in a systematic way.

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