ESSEC Working Papers,
ESSEC Research Center, ESSEC Business School

Abstract: Basel II and Solvency 2 both use the Value-at Risk (VaR) as the risk measure to compute the Capital Requirements. In practice, to calibrate the VaR, a normal approximation is often chosen for the unknown distribution of the yearly log returns of financial assets. This is usually justified by the use of the Central Limit Theorem (CLT), when assuming aggregation of independent and identically distributed (iid) observations in the portfolio model. Such a choice of modeling, in particular using light tail distributions, has proven during the crisis of 2008/2009 to be an inadequate approximation when dealing with the presence of extreme returns; as a consequence, it leads to a gross underestimation of the risks. The main objective of our study is to obtain the most accurate evaluations of the aggregated risks distribution and risk measures when working on financial or insurance data under the presence of heavy tail and to provide practical solutions for accurately estimating high quantiles of aggregated risks. We explore a new method, called Normex, to handle this problem numerically as well as theoretically, based on properties of upper order statistics. Normex provides accurate results, only weakly dependent upon the sample size and the tail index. We compare it with existing methods.

Keywords: Aggregated risk; (refined) Berry-Esséen Inequality; (generalized) Central Limit Theorem; Conditional (Pareto) Distribution; Conditional (Pareto) Moment; Convolution; Expected Short Fall; Extreme Values; Financial Data; High Frequency Data; Market Risk; Order Statistics; Pareto Distribution; Rate of Convergence; Risk Measures; Stable Distribution; Value-at-Risk

JEL-codes: C10; C53; G12

33 pages, November 2013

Full text files

WP1317.pdf  

Download statistics

• ESSEC Research Center, ESSEC Business School
• Home page for this series

Questions (including download problems) about the papers in this series should be directed to Sophie Magnanou ()
Report other problems with accessing this service to Sune Karlsson ().

This page generated on 2024-02-05 15:47:17.