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Asset allocation when guarding against catastrophic losses: a comparison between the structure variable and joint probability methods
Authors:Brendan O Bradley  Murad S Taqqu
Institution:1. Acadian Asset Management , Ten Post Office Square, Boston, MA 02109, USA E-mail: bbradley@acadian-asset.com;2. Department of Mathematics and Statistics , Boston University , 111 Cummington Street, Boston, MA 02215, USA E-mail: murad@bu.edu
Abstract:We apply a bivariate approach to the asset allocation problem for investors seeking to minimize the probability of large losses. It involves modelling the tails of joint distributions using techniques motivated by extreme value theory. We compare results with a corresponding univariate approach using simulated and financial data. Through an examination of a simulated and real financial data set we show that the estimated risks using the bivariate and univariate approaches are in close agreement for a wide range of losses and allocations. This is important since the bivariate approach is significantly more computationally expensive. We therefore suggest that the univariate approach be used for the typical level of loss that an investor may want to guard against. This univariate approach is effective even if there are more than two assets. The software written in support of this work is available on demand and we describe its use in the appendix.
Keywords:Financial time series  Statistics  Financial econometrics  Financial modelling
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