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

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Stochastic Volatilities and Correlations, Extreme Values and Modeling the Macroeconomic Environment, Under Which Brazilian Banks Operate
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Volume/Issue:
2007/290
Series:
IMF Working Papers
Author(s):
Marcos Souto, and Theodore Barnhill
Publisher:
INTERNATIONAL MONETARY FUND
Published Date:
December 2007
DOI:
http://dx.doi.org/10.5089/9781451868531.001
ISBN:
9781451868531
ISSN:
1018-5941
Page:
52
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.
Article

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

Author(s):
Marcos Souto, and Theodore Barnhill
Published Date:
December 2007
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