Stochastic Volatilities and Correlations, Extreme Values and Modeling the Macroeconomic Environment, Under Which Brazilian Banks Operate

December 1, 2007

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Marcos R Souto, and Theodore M. Barnhill Stochastic Volatilities and Correlations, Extreme Values and Modeling the Macroeconomic Environment, Under Which Brazilian Banks Operate, (USA: International Monetary Fund, 2007) accessed September 20, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Using monthly data for a set of variables, we examine the out-of-sample performance of various variance/covariance models and find that no model has consistently outperformed the others. We also show that it is possible to increase the probability mass toward the tails and to match reasonably well the historical evolution of volatilities by changing a decay factor appropriately. Finally, we implement a simple stochastic volatility model and simulate the credit transition matrix for two large Brazilian banks and show that this methodology has the potential to improve simulated transition probabilities as compared to the constant volatility case. In particular, it can shift CTM probabilities towards lower credit risk categories.

Subject: Banking, Commodities, Credit, Credit risk, Financial regulation and supervision, Foreign exchange, Gold, Money, Oil

Keywords: Br rate, Covariances model, Credit, Credit risk, Fat-tail distributions, Forecasting, FX rate, Gold, Monte Carlo estimation, Normal distribution, Oil, Standard deviation, Stochastic volatility, Time series, Wilk-Shapiro statistics, WP

Publication Details

Pages:

52
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2007/290
Stock No:

WPIEA2007290
ISBN:

9781451868531
ISSN:

1018-5941

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