The choice of the distribution of asset returns: How extreme value theory can help? [An article from: Journal of Banking and Finance]

This digital document is a journal article from Journal of Banking and Finance, published by Elsevier in 2005. The article is delivered in HTML format and is available in your Amazon.com Media Library immediately after purchase. You can view it with any web browser.

Description:
One of the issues of risk management is the choice of the distribution of asset returns. Academics and practitioners have assumed for a long time (for more than three decades) that the distribution of asset returns is a Gaussian distribution. Such an assumption has been used in many fields of finance: building optimal portfolio, pricing and hedging derivatives and managing risks. However, real financial data tend to exhibit extreme price changes such as stock market crashes that seem incompatible with the assumption of normality. This article shows how extreme value theory can be useful to know more precisely the characteristics of the distribution of asset returns and finally help to chose a better model by focusing on the tails of the distribution. An empirical analysis using equity data of the US market is provided to illustrate this point.