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18 - Extreme Risk and Fat-Tails Distribution Model

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37 views2 pages

18 - Extreme Risk and Fat-Tails Distribution Model

Research Paper

Uploaded by

Agha
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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The paper "Extreme Risk and Fat-Tails Distribution Model: Empirical Analysis"

by Ibrahim A. Onour examines extreme risk behavior in financial markets,


focusing on modeling "fat-tailed" distributions, where extreme events are more
probable than in normal distributions. This paper provides insight into the
characteristics of extreme market risks and the effectiveness of fat-tailed
distribution models in capturing them. Here is a detailed summary:

i. Title:

"Extreme Risk and Fat-Tails Distribution Model: Empirical Analysis"


Author: Ibrahim A. Onour

ii. Abstract of the Paper:

The paper investigates the presence and implications of fat-tailed distributions in


financial markets, where extreme events (e.g., large price jumps or market crashes)
occur more frequently than predicted by traditional models. By empirically
analyzing market data, the study assesses how well fat-tailed distribution models
capture these risks and evaluates the suitability of these models for extreme risk
management and forecasting.

iii. Objectives of the Paper:

The main objectives are:

1. To explore the presence of fat-tailed distributions in financial market data,


particularly focusing on extreme risks.
2. To determine the effectiveness of fat-tail models in estimating the
probability and magnitude of extreme market events.
3. To provide insights for risk managers and policymakers on the use of fat-
tailed models for better risk assessment and mitigation in volatile markets.

iv. Methodology:

The paper uses empirical analysis of financial data to evaluate the applicability of
fat-tail models. Methodological steps include:

1. Collecting high-frequency data on stock prices or market indices over a


significant period.
2. Applying statistical tests to assess the presence of fat tails in the data
distribution.
3. Comparing the fit of fat-tail models to standard normal distribution models
in terms of capturing extreme market events.

v. Models:

The primary models used in the analysis are:

1. Generalized Extreme Value (GEV) Distribution - Employed to model


extreme events and evaluate the frequency and magnitude of tail risks in
financial data.
2. Pareto and Lévy-Stable Distributions - Used to capture the heavy tails of
the distribution and estimate the probability of extreme losses.
3. Value-at-Risk (VaR) and Expected Shortfall (ES) - Applied within fat-tail
frameworks to quantify potential losses in extreme market conditions,
providing a benchmark for comparing model performance.

vi. Findings and Conclusion:

The study finds that fat-tailed distribution models, particularly the Generalized
Extreme Value and Pareto models, more accurately capture the frequency and
magnitude of extreme risks in financial markets than traditional normal
distributions. The findings highlight the need for financial institutions to adopt fat-
tail models for risk assessment, as these models are better suited for estimating
potential losses during extreme events. The paper concludes that relying on normal
distribution models may underestimate risk exposure, potentially leading to
inadequate risk management strategies. It suggests that policymakers and risk
managers use fat-tailed models for more robust planning and preparedness against
rare but severe market events.

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