Article ID | Journal | Published Year | Pages | File Type |
---|---|---|---|---|
5090378 | Journal of Banking & Finance | 2010 | 12 Pages |
Abstract
Why should risk management systems account for parameter uncertainty? In addressing this question, the paper lets an investor in a credit portfolio face non-diversifiable uncertainty about two risk parameters - probability of default and asset-return correlation - and calibrates this uncertainty to a lower bound on estimation noise. In this context, a Bayesian inference procedure is essential for deriving and analyzing the main result, i.e. that parameter uncertainty raises substantially the tail risk perceived by the investor. Since a measure of tail risk that incorporates parameter uncertainty is computationally demanding, the paper also derives a closed-form approximation to such a measure.
Related Topics
Social Sciences and Humanities
Economics, Econometrics and Finance
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Authors
Nikola Tarashev,