What drives tail risk in aggregate European equity markets?

Abstract

Purpose – The paper aims to analyse the drivers of changes in European equity tail risk. Design/methodology/approach – For this purpose, the paper uses a panel data model with fixed effects based on five explanatory variables including the VIX, the variance risk premium (VRP), the one-year lagged slope of the riskless term-structure, the default spread and market-specific illiquidity via the measure of Bao et al. (2011). The study analyses a comprehensive database of representative European equity indices from February 2003 to December 2013. The database just contains markets of euro member states to avoid biases due to different currencies. To measure equity tail risk, the ex post realized value-at-risk was used. Findings – There is empirical evidence that the VIX, the VRP and the default spread are key determinants of equity tail risk changes across all markets. Moreover, the results reveal that market-specific illiquidity is an important determinant in PIIGS markets and the one-year lagged term-structure slope in core markets. The analysis also documents that market-specific risk premia are a relevant determinant of equity tail risk changes. Another finding is that risk premia in PIIGS markets are basically higher as in core markets, which reflect the higher risk involved in investing in PIIGS markets. Originality/value – The paper offers a unique perspective on equity tail risk in aggregate equity markets and helps both investors and risk managers to get a comprehensive understanding of relevant drivers.

Portfolio allocation across variance risk premia

“…Thus, it is computed as the difference between the model-free IV ( IV t ) and the model-free realized volatility ( RV t ) for a given asset. A similar presentation can be found in Kinateder (2015).…”

“…Portfolio dynamics (in the case of illiquidity) have been recently studied as well by Buchner (2016). The paper closest to us in the spirit is that by Kinateder (2015), who analyzes the critical determinants of ex post tail risk in European equity markets by considering as explanatory variables the VIX, the VRP, and the default spread.…”

A Statistical Analysis of Cryptocurrencies

“…Value at risk (VaR) and expected shortfall (ES) are the two most popular financial risk measures (Kinateder 2015(Kinateder , 2016. If F(·) denotes the cdf of the best fitting distribution then VaR and ES corresponding to probability q can be defined by …”