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Worst-Case Higher Moment Risk Measure: Addressing Distributional Shifts and Procyclicality

Author

Listed:
  • Castro-Iragorri, Carlos

    (Facultad de Economía Universidad del Rosario)

  • Gómez, Fabio

    (Facultad de Economía Universidad del Rosario)

  • Quiceno, Nancy

    (Camara de Riesgo Central de Contraparte, CRCC)

Abstract

This paper addresses the inherent procyclicality in widely adopted financial risk measures, such as Expected Shortfall (ES). We propose an innovative approach utilizing the Higher Moment (HM) risk measure, which offers a robust solution to distributional shifts by incorporating adaptive features. Empirical results using historical S&P500 returns indicate that worst-case HM risk measures significantly reduce the underestimation of risk and provide more stable risk assessments throughout the financial cycle compared to traditional ES predictions. These results suggest that HM risk measures represent a viable alternative to regulatory add-ons for stress testing and procyclicality mitigation in financial risk management.

Suggested Citation

  • Castro-Iragorri, Carlos & Gómez, Fabio & Quiceno, Nancy, 2024. "Worst-Case Higher Moment Risk Measure: Addressing Distributional Shifts and Procyclicality," Documentos de Trabajo 21048, Universidad del Rosario.
    • Handle: RePEc:col:000092:021048
    as

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    References listed on IDEAS

    as
    1. N. Bloom, 2016. "Fluctuations in uncertainty," Voprosy Ekonomiki, NP Voprosy Ekonomiki, issue 4.
    2. PAVLO A. Krokhmal, 2007. "Higher moment coherent risk measures," Quantitative Finance, Taylor & Francis Journals, vol. 7(4), pages 373-387.
    3. Matmoura, Yassine & Penev, Spiridon, 2013. "Multistage optimization of option portfolio using higher order coherent risk measures," European Journal of Operational Research, Elsevier, vol. 227(1), pages 190-198.
    4. Tobias Adrian & Hyun Song Shin, 2014. "Procyclical Leverage and Value-at-Risk," The Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 373-403.
    5. Gordy, Michael B. & Howells, Bradley, 2006. "Procyclicality in Basel II: Can we treat the disease without killing the patient?," Journal of Financial Intermediation, Elsevier, vol. 15(3), pages 395-417, July.
    6. Fabio Bellini & Elena Di Bernardino, 2017. "Risk management with expectiles," The European Journal of Finance, Taylor & Francis Journals, vol. 23(6), pages 487-506, May.
    7. Gómez, Fabio & Tang, Qihe & Tong, Zhiwei, 2022. "The gradient allocation principle based on the higher moment risk measure," Journal of Banking & Finance, Elsevier, vol. 143(C).
    8. Jose Blanchet & Lin Chen & Xun Yu Zhou, 2022. "Distributionally Robust Mean-Variance Portfolio Selection with Wasserstein Distances," Management Science, INFORMS, vol. 68(9), pages 6382-6410, September.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    procyclicality; higher moment risk; stress testing; expected shortfall;
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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