DP2762 New Extreme-Value Dependence Measures and Finance Applications

Author(s): Ser-Huang Poon, Michael Rockinger, Jonathan Tawn
Publication Date: April 2001
Keyword(s): Asymptotic Independence, Extreme Value Theory, Hill's Estimator, Tail Index
JEL(s): C13, C22, G11, G15
Programme Areas: Financial Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2762

In the finance literature, cross-sectional dependence in extreme returns of risky assets is often modelled implicitly assuming an asymptotically dependent structure. If the true dependence structure is asymptotically independent then existing finance models will lead to over-estimation of the risk of simultaneous extreme events. We provide simple techniques for deciding between these dependence classes and for quantifying the degree of dependence in each class. Examples based on daily stock market returns show that there is strong evidence in favour of asymptotically independent models for dependence in extremal stock market returns, and that most of the extremal dependence is due to heteroskedasticity in stock returns processes.