Downside risk measurement in regime switching stochastic volatility

Mitra, S. 2020. Downside risk measurement in regime switching stochastic volatility. Journal of Computational and Applied Mathematics. 378 112845. https://doi.org/10.1016/j.cam.2020.112845

TitleDownside risk measurement in regime switching stochastic volatility
TypeJournal article
AuthorsMitra, S.
Abstract

Risk measurement is important to firms to enable management of risks, and ensure profitability during different firm and market events. In particular, downside risk is an important risk measure as it is a coherent risk measure, and it is also compatible with industry risk management approaches such as stop losses. Whilst regime switching models have been used for downside risk measurement, the regime switching models for stochastic volatility dynamics have been limited and so restrict risk measurement. In this paper we propose a new regime switching model that incorporates non-trivial stochastic volatility dynamics, hence we are able to measure risk more realistically. We derive the downside risk measure associated with our regime switching model, for risk measurement including and excluding jump risk. We prove that the regime switching model converges to the underlying continuous time asset pricing model, hence our risk measurement is consistent. We provide a discretisation for the variance risk process, which is locally consistent and enables computational implementation. We also provide numerical experiments to illustrate our method.

Article number112845
JournalJournal of Computational and Applied Mathematics
Journal citation378
ISSN0377-0427
1879-1778
Year2020
PublisherElsevier
Accepted author manuscript
License
CC BY-NC-ND 4.0
File Access Level
Open (open metadata and files)
Digital Object Identifier (DOI)https://doi.org/10.1016/j.cam.2020.112845
Publication dates
PublishedNov 2020

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