Abstract

ROGEL-SALAZAR, Jesús  and  TELLA, Roberto. Portfolio Construction Based on Implied Correlation Information and Value at Risk. EconoQuantum [online]. 2015, vol.12, n.1, pp.125-144. ISSN 2007-9869.

Value at Risk (VaR) is a commonly used downside-risk measure giving the worst-case asset loss over a target horizon for a given confidence level. Implied correlation from VaR is an alternative form of the correlation coefficient calculated not only based on historic performance, but taking into account a forecast of the worst-loss. Given its importance, here we present a treatment that is accessible to undergraduate students in economics, finance and similar areas with the aim of familiarising the reader with this risk measure. With the use of three case studies we analyse the effect that implied correlation from VaR has on portfolios of increasing asset size. The VaR of each asset is calculated as well as a mean implied correlation, , which is used to adjust the original portfolio’s invested fractions in order to view the shift in risk and return. We track comparative portfolios over a 50-day period to identify trends between portfolio type and risk encountered.

Keywords : Implied correlation; Value at Risk; VaR; Portfolio construction; Risk.