Security prices contain valuable information that can be used to make a wide variety of economic decisions. To extract this information, a model is required that relates market prices to the desired information, and that ideally can be implemented using timely and low-cost methods.
Understanding the nature of credit risk has important implications for financial stability. Since authorities – notably, central banks – focus on risks that have systemic implications, it is crucial to develop ways to measure these risks.
We propose a framework that allows a portfolio manager to quantify the probability of simultaneous losses in multiple assets of a collateral portfolio. Using this framework, we propose a methodology to conduct stress tests on the market value of the portfolio of collateral when undesirable extreme dependence occurs.
The authors examine how the use of extreme value theory yields collateral requirements that are robust to extreme fluctuations in the market price of the asset used as collateral.
