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Measuring potential market risk

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  • Bask, Mikael

Abstract

We argue herein that there is a fundamental and an important difference between the market risk and the potential market risk in financial markets. We also argue that the spectrum of smooth Lyapunov exponents can be used in ([lambda],[sigma]2)-analysis, which is a method to measure and monitor these risks. The reason is that these exponents focus on the stability properties ([lambda]) of the stochastic dynamic system generating asset returns, while more traditional risk measures such as value-at-risk are concerned with the distribution of asset returns ([sigma]2).

Suggested Citation

  • Bask, Mikael, 2010. "Measuring potential market risk," Journal of Financial Stability, Elsevier, vol. 6(3), pages 180-186, September.
    • Handle: RePEc:eee:finsta:v:6:y:2010:i:3:p:180-186
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    1. Shintani, Mototsugu & Linton, Oliver, 2004. "Nonparametric neural network estimation of Lyapunov exponents and a direct test for chaos," Journal of Econometrics, Elsevier, vol. 120(1), pages 1-33, May.
    2. Bask, Mikael & Liu, Tung & Widerberg, Anna, 2007. "The stability of electricity prices: Estimation and inference of the Lyapunov exponents," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 376(C), pages 565-572.
    3. Gencay Ramazan & Dechert W. Davis, 1996. "The Identification of Spurious Lyapunov Exponents in Jacobian Algorithms," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 1(3), pages 1-12, October.
    4. Simón Sosvilla-Rivero & Fernando Fernández-Rodriguez & Julián Andrada-Félix, 2005. "Testing chaotic dynamics via Lyapunov exponents," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 20(7), pages 911-930.
    5. Mototsugu Shintani, 2006. "A nonparametric measure of convergence towards purchasing power parity," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(5), pages 589-604.
    6. Bask, Mikael & de Luna, Xavier, 2005. "EMU and the stability and volatility of foreign exchange: Some empirical evidence," Chaos, Solitons & Fractals, Elsevier, vol. 25(3), pages 737-750.
    7. Potter, Simon M., 2000. "Nonlinear impulse response functions," Journal of Economic Dynamics and Control, Elsevier, vol. 24(10), pages 1425-1446, September.
    8. Bask, Mikael & Widerberg, Anna, 2007. "The Stability and Volatility of Electricity Prices: An Illustration of (lambda, sigma-2) Analysis," Working Papers in Economics 267, University of Gothenburg, Department of Economics.
    9. Bask Mikael & de Luna Xavier, 2002. "Characterizing the Degree of Stability of Non-linear Dynamic Models," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 6(1), pages 1-19, April.
    10. Dechert, W D & Gencay, R, 1992. "Lyapunov Exponents as a Nonparametric Diagnostic for Stability Analysis," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages 41-60, Suppl. De.
    11. Bask, Mikael & Widerberg, Anna, 2009. "Market structure and the stability and volatility of electricity prices," Energy Economics, Elsevier, vol. 31(2), pages 278-288, March.
    12. Leeves, Gareth, 2007. "Asymmetric volatility of stock returns during the Asian crisis: Evidence from Indonesia," International Review of Economics & Finance, Elsevier, vol. 16(2), pages 272-286.
    13. Xavier De Luna, 1998. "Projected polynomial autoregression for prediction of stationary time series," Journal of Applied Statistics, Taylor & Francis Journals, vol. 25(6), pages 763-775.
    14. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
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    Cited by:

    1. Sekandary, Ghezal & Bask, Mikael, 2023. "Monetary policy uncertainty, monetary policy surprises and stock returns," Journal of Economics and Business, Elsevier, vol. 124(C).
    2. Mikael Bask & Anna Widerberg, 2012. "Actual and potential market risks during the stock market turmoil 2007--2008," Applied Financial Economics, Taylor & Francis Journals, vol. 22(5), pages 339-349, March.

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    More about this item

    Keywords

    Market risk Potential market risk Smooth Lyapunov exponents Stochastic dynamic system;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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