On time-scaling of risk and the square-root-of-time rule
Many financial applications, such as risk analysis, and derivatives pricing, depend on time scaling of risk. A common method for this purpose is the square-root-of-time rule where an estimated quantile of a return distribution is scaled to a lower frequency by the square root of the time horizon. Th...
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| Veröffentlicht in: | Journal of banking & finance 2006-10, Vol.30 (10), p.2701-2713 |
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| container_title | Journal of banking & finance |
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| creator | Daníelsson, Jón Zigrand, Jean-Pierre |
| description | Many financial applications, such as risk analysis, and derivatives pricing, depend on time scaling of risk. A common method for this purpose is the square-root-of-time rule where an estimated quantile of a return distribution is scaled to a lower frequency by the square root of the time horizon. This paper examines time scaling of quantiles when returns follow a jump diffusion process. We demonstrate that when jumps represent losses, the square-root-of-time rule leads to a systematic underestimation of risk, whereby the degree of underestimation worsens with the time horizon, the jump intensity and the confidence level. |
| doi_str_mv | 10.1016/j.jbankfin.2005.10.002 |
| format | Article |
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| ispartof | Journal of banking & finance, 2006-10, Vol.30 (10), p.2701-2713 |
| issn | 0378-4266 1872-6372 |
| language | eng |
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| source | RePEc; Elsevier ScienceDirect Journals Complete |
| subjects | Estimating techniques Financial economics Jump diffusions Poisson distribution Rates of return Risk assessment Risk regulation Square-root-of-time rule Studies Systemic risk Time scaling of risk Value-at-risk Volatility |
| title | On time-scaling of risk and the square-root-of-time rule |
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