Systematic risk under extremely adverse market conditions

Extreme losses are the major concern in risk management. The dependence between financial assets and the market portfolio changes under extremely adverse market conditions. We develop a measure of systematic tail risk, the tail regression beta, defined by an asset’s sensitivity to large negative market shocks, and establish the estimation methodology. We compare it to regular systematic risk measures: the market beta and the downside beta. Furthermore, the tail regression beta is a useful instrument in both portfolio risk management and systemic risk management. We demonstrate its applications in analyzing Value-at-Risk (VaR) and Conditional Value-at-Risk (CoVaR).

Keywords: Tail regression beta, downside risk, Extreme Value Theory, tail dependence, risk management.

JEL Classification: C14, G11.

Working paper no. 281