Portfolio risk and stress across the business cycle

Abstract

In this study, we investigate the interactions of daily tail risk estimates of thirty market indices representing a broad spectrum of asset classes and geographies from 2003 till 2021 and document important findings. Using a step-by-step conditional copula with orthogonalized GARCH margins augmented further with Markov-switching transitions, we study the dependence structure across the asset classes. Our results predominantly indicate the presence of contagion in tail risk across assets and geographies, especially during economy-wide stress. Our results suggest that alternative asset classes are crucial in mitigating overall portfolio risk. Our results also show the magnitude of tail risk contagion amongst countries studied.