Theoretical and Applied Economics Volume XVIII (2011), No. 2(555), pp. 75-88 Portfolio Risk Analysis using ARCH and GARCH Models in the Context of the Global Financial Crisis* Oana Mădălina PREDESCU Bucharest Academy of Economic Studies predescu_oana85@yahoo.com Stelian STANCU Bucharest Academy of Economic Studies stelian_stancu@yahoo.com Abstract. This paper examines both the benefits of choosing an internationally diversified portfolio and the evolution of the portfolio risk in the context of the current global financial crisis. The portfolio is comprised of three benchmark indexes from Romania, UK and USA. Study results show that on the background of a global economic climate eroded strongly by the effects of the current financial …show more content…
Rubinstein (2002) appreciated that Markowitz’s research represents the first mathematical formalization of the diversification concept of investments, Portfolio Risk Analysis using ARCH and GARCH Models in the Context of the Global Financial Crisis 77 emphasizing the fact that even though diversification reduces risk, it can not eliminate it completely. So, through diversification risk can be reduced without having any effects on the portfolio expected return. Thus, sub-perfectly correlated securities represent the “right candidates” to be included in a portfolio. Solnik (1974), among others, extended the initial CAPM (Capital Asset Pricing Model) and suggested that international diversification leads to better results than domestic diversification. However, financial integration leads to a significant correlation of security returns, the benefits of international diversification being greatly reduced (Aloui, 2010). Taking all these aspects into consideration, the present paper aims to analyze the evolution of the risk of an internationally diversified portfolio in the context of the current financial crisis. The remainder of the paper is organized as follows: Section 2 presents theoretical aspects related to the volatility measurement of financial time series using ARCH and GARCH models; in Section 3 we report the empirical results of our study and in Section 4 we provide a summary of our conclusions.
As well as significant events that occurred on September 11, 2001, the associated risks in international relations has increased substantially, and it becomes more difficult to be analyzed and predicted for decision-makers in the fields of Economics, finance and politics. International investors are also aware that the globalization of world trade and capital market openness poses a risk that could cause the financial
The extracted data used includes monthly returns from January 1972 to July 2011. The assets are selected so that the portfolio contains the largest, most liquid, and most tradable assets. The choice of such a variety of assets across several markets was used in order to generate a large cross sectional dispersion in average return. It helped to reveal new factor exposure and define a general framework of the correlated value and momentum effects in various asset classes.
Advisors and investors would do well to pay as much attention to the expected volatility of any portfolio or investment as they do to anticipated returns. Moreover, all things being equal, a new investment should only be added to a portfolio when it either reduces the expected risk for a targeted level of returns, or when it boosts expected portfolio returns without adding additional risk, as measured by the expected standard deviation of those returns. Lesson 2: Don’t assume bonds or international stocks offer adequate portfolio diversification. As the world’s financial markets become more closely correlated, bonds and foreign stocks may not provide adequate portfolio diversification. Instead, advisors may want to recommend that suitable investors add modest exposure to nontraditional investments such as hedge funds, private equity and real assets. Such exposure may bolster portfolio returns, while reducing overall risk, depending on how it is structured. Lesson 3: Be disciplined in adhering to asset allocation targets. The long-term benefits of portfolio diversification will only be realized if investors are disciplined in adhering to asset allocation guidelines. For this reason, it is recommended that advisors regularly revisit portfolio allocations and rebalance
“The Benefits of diversification are clear. Portfolio theory has played a crucial role in explaining the relationship between risk and return where more than one investment is held. It also enables us to identify optimal and efficient portfolios.”
The goal of this paper is to explain why CCM’s aggressive program is a good alternative to any investor looking to diversify its portfolio. The paper will be divided into three distinct parts: the operational analysis, the quantitative analysis and a comparison against its peers (including the impact of CCM in a traditional portfolio).
When charted across the largest financial institutions during the 2008 Financial Crisis, it delivers great results. It would have targeted Fannie Mae, Freddie Mac, Morgan Stanley, Bear Stearns, and Lehman Brothers as the most fragile institutions. Moreover, the model could detect the problems as early as the first quarter of 2005, making it a promising predictive tool. Such a risk-measurement instrument can be useful for firms of all sizes: from medium to large-scale funds, to the largest institutional investment houses.
Diversification of risk is not putting all your money into one thing, such all putting your money into all bonds. You can diversify your investments by investing in different things such as international stocks, DJIA, bonds, and different types of stocks.
The economic turmoil of 2008 is arguably the worst financial crisis since the great depression of the 1930s. Although financial crisis is not entirely new, each one is characterized by unique challenges that make it difficult to make a prediction on when and how the next financial crisis might occur. The financial crisis of 2008 to 2009 was marked by a failure in the efficiency of the financial markets, inability of regulatory bodies to regulate the financial product and was catalyzed by weak macroeconomic fundamentals prevailing at the time. In the aftermath of the turmoil financial crisis, there has been a debate in the financial community on whether there are specific indicators that precipitate a financial crisis and whether the global economy is at a risk of experiencing the a repeat of a financial crisis of a similar nature to the crisis of 2008. The
Since the great depression, the global economy has been facing a number of ups and downs. With the markets being built rapidly and crashing down in the other instant, elements that actually make up the skeleton of the international economy seems to have correlated variables. These variables seems to have been correlated with each other in numerous combinations and their correlation is what makes the market fluctuate. The volatility of the global market becomes more apparent in times of recession when the correlation between variables like stocks, bonds, US dollar, Euro, gold and oil becomes more apparent. Therefore, it is of paramount importance that these correlated variables should be studied with a very keen eye. Since the link between currencies, commodities, stocks an bonds runs very deep, change in any one of them seems to have a profound impact on the rest hence changing the face of the market.
Diversity investment among stock markets, bounds and nationally and internationally is the best me method of maintaining the risk of investment and expanding its growth. The fourth importance is the cost of single investment; the less money an investor pay; the more financial resources will have to take advantage on future investment opportunities that expand the return. Becker’s final advice of investment success was for investors to slick with their plan. “Lethargy bordering on sloth remains the cornerstone of our investment style”, Warren Buffett. Many investors get influenced by what goes around them and the media to end their investment prematurely or get involved in risky commitment outside of their goals.
It would be great to live in a world where investing provided guaranteed payout with little or no risk, however, we all realize that is not the way investing works. Generally, the greater the risk, the greater potential for return or worse, loss. How we perceive and respond to risk is a very personal decision and there are several factors that go into making that decision. In this paper, I will discuss the risk of stock investing. There are two types of risk involved in investing in stock. One is diversifiable risk and is completely controlled by the investor. It means that a portfolio should be filled with stocks of varying degrees of risk. The other type of risk is market risk. The
Understanding market risk is crucial in determining the factors that threaten one’s ability to attain returns from a particular project, single stock, or a portfolio. The impact of market risks is crucial to determining stability and the return on an investment. Many factors impact the market risk which effect both global and country economies. Market risk allows a firm to estimate the risk and return on projects or investments. Generally the riskier the project, the higher the returns. Market risk is predictable over time; although the predictions are not perfect, one can gain understanding into the effects the market will have on investment or how the investment will react to
It did not matter what type of security it was; the crisis affected the entire market. However, different classes of assets are affected in different ways. To figure out the systemic risk of a particular industry, security, or portfolio, and to see how that systemic risk compares to the overall market’s systemic risk, investors and others use beta.
Just after ten years of Asian financial crisis, another major financial crisis now concern for all developed and some developing countries is “Global Financial Crisis 2008.” It is beginning with the bankruptcy of Lehman Brothers on Sunday, September 14, 2008 and spread like a flood. At first U.S banking sector fall in a great liquidity crisis and simultaneously around the world stock markets have fallen, large financial institutions have collapsed or been bought out, and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems. (Global issue)
Diversification is a method of investing that been shown to increase portfolio return while reducing portfolio risk as measured by standard deviation. This method specifically increases the efficient frontier for investors. The challenge to an investing firm is an appetite by its customers for an ever increasing efficient frontier. One area to explore to obtain this increase is through further diversifying through international diversification.