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Förslaget inkom 2008-01-22

Correlation measures in coordinated sell-off events

OBS! ANSÖKNINGSTIDEN FÖR DETTA EXJOBB HAR LÖPT UT.
Diversification is in the core of modern portfolio management. Investors can reduce their exposure to sectors or moves in individual assets by holding a diversified portfolio of assets. The portfolio's volatility, or the risk of the portfolio, is a function of the correlation between assets. Under normal circumstances the correlations between genuinely different assets like futures on Live cattle and Japanese government bonds are neglectable. Holding them together in a portfolio will give diversification benefits just as theory predicts. Though, if the assets suddenly move in sync, the diversification effect disappears.

Recently we have seen market events when the correlations between apparently uncorrelated assets suddenly spikes. These 'nowhere-to-hide'-events are associated with substantial market corrections where a broad range of assets fall simultaneously. For a portfolio manager it is essential to be aware of the risk of such a correction and even try to estimate the probability of correlation spikes.

The purpose of this master thesis project is to make an extensive overview of possible methods to construct a risk measure for coordinated market sell-offs based on correlation forecasting. The starting point will be the Dynamic Equicorrelation Models for Large Correlations Matrices (DECO) by Robert Engel, based on an ARCH-approach. The most promising methods will be implemented and compared using daily data provided by RPM. Necessary requirement are a firm base in mathematical finance and programming, with strong skills in SQL and either Matlab, C#/.NET or any of the statistical analysis tools held in-house.


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