A PROJECT

ON
PORTFOLIO SELECTION USING EXTREME VALUE
THEORY.


UNDER THE GUIDENCE OF
Prof. ALOK PANDEY

SUBMITTED BY
SHANTANU BHARGAVA
PGDM(FINANCE)
229/2013




LAL BAHADUR SHASTRI INSTITUTE OF MANAGEMENT NEW DELHI




SYNOPSIS
TITLE
PORTFOLIO SELECTION USING EXTREME VALUE THEORY
PROBLEM STATEMENT
The problem of selecting a portfolio has been largely faced in terms of minimizing the risk,
given the return.In this study we deal with the portfolio problem using extreme value
theory(EVT).We show that the portfolio which have low tail dependency will outperform
market indices.
OBJECTIVE OF THE STUDY
1. To apply extreme value theory for the selection of portfolio
2. To show that low tail dependency is important for risk averse investors and
substantially differs from other risk measures
3. To show that low tail dependent portfolio outperform market indices
Scope of the study:
The scope of the study is to select best portfolio out of many portfolio available in market.A
sincere attempt has been made to include all the aspect relating to study.for this purpose
analysis of stock price of the company has done from the last ten years.
METHODOLOGY.

The word method indicates the mode or the way of accomplishing an objective. For this
purpose research is done by using secondary data collected through various online and offline
database.Research is done using analytical tools like eviews and Microsoft excel.
Secondary data
Secondary data means data that are already available that is the data which have already been
collected and analysed by someone else. When the researcher utilizes the secondary data,
then he has to look into various sources from where he can obtain them. In this case data is

collected using various online and offline database available,like prowess,ace equity,yahoo
finance and nseindia which provides historical data for various companies
LITERATURE REVIEW:
PORTFOLIO SELECTION: AN EXTREME VALUE APPROACH BY
FRANCIS J. DITRAGLIA, JEFFREY R. GERLACH
The paper shows theoretically that lower tail dependence() , a measure of the probability
that a portfolio will suffer large losses given that the market does, contains important
information for risk-averse investors. We then estimate for a sample of DJIA stocks and
show that it differs systematically from other risk measures. In out-of-sample tests, portfolios
constructed to have low values of outperform the market index, the mean return of the
stocks in our sample, and portfolios with high values of . Our results indicate that is
conceptually important for risk-averse investors, differs substantially from other risk
measures, and provides useful information for portfolio selection.
STATISTICS OF EXTREMES BY RICHARD L. SMITH
Extreme value theory is concerned with probabilistic and statistical questions related to very
high or very low values in sequences of random variables and in stochastic processes. The
subject has a rich mathematical theory and also a long tradition of applications in a variety of
areas.

RARE DISASTERS AND ASSET MARKETS IN THE TWENTIETH
CENTURY BY ROBERT J. BARRO

The potential for rare economic disasters explains a lot of asset-pricing puzzles. The paper
calibrate disaster probabilities from the twentieth century global history, especially the sharp
contractions associated with World War I, the Great Depression, and World War II. The
puzzles that can be explained include the high equity premium, low risk-free rate, and volatile
stock returns. Another mystery that may be resolved is why expected real interest rates were
low in the United States during major wars, such as World War II.









STEPS IN APPLYING EXTREME VALUE THEORY TO FINANCE: A
REVIEW BY YOUNES BENSALAH

Extreme value theory (EVT) has been applied in fields such as hydrology and insurance. It is
a tool used to consider probabilities associated with extreme and thus rare events. EVT is
useful in modelling the impact of crashes or situations of extreme stress on investor
portfolios. Contrary to value-at-risk approaches, EVT is used to model the behaviour of
maxima or minima in a series (the tail of the distribution). However, implementation of EVT
faces many challenges, including the scarcity of extreme data, determining whether the series
is fat-tailed, choosing the threshold or beginning of the tail, and choosing the methods of
estimating the parameters. This paper focuses on the univariate case; the approach is not
easily extended to the multivariate case, because there is no concept of order in a
multidimensional space and it is difficult to define the extremes in the multivariate case.
Following a review of the theoretical literature, univariate EVT techniques are applied to a
series of daily exchange rates of Canadian/U.S. dollars over a 5-year period (19952000).

INTERNATIONAL DIVERSIFICATION: AN EXTREME VALUE
APPROACH BY LORAN CHOLLETE, VICTOR DE LA PENA, AND
CHING-CHIH LU

International diversification has costs and benefits, depending on the degree of asset
dependence. In light of theoretical research linking diversification and dependence, we
examine international diversification with two dependence measures: correlations and
extreme dependence. We document several findings. First, dependence has generally
increased over time. Second, there is evidence of asymmetric dependence or downside risk in
all regions, albeit at different times. Surprisingly, recent Latin American returns exhibit little
downside risk. Third, Latin America exhibits a great deal of correlation complexity. Fourth,
extreme dependence is related to returns. Our results suggest international limits to
diversification. They are also consistent with a possible tradeoff between international
diversification and systemic risk.








THE CHOICE OF THE DISTRIBUTION OF ASSET RETURNS: HOW
EXTREME VALUE THEORY CAN HELP? BY FRANCOIS LONGIN

One of the issues of risk management is the choice of the distribution of asset returns.
Academics and practitioners have assumed for a long time (for more than three decades) that
the distribution of asset returns is a Gaussian distribution. Such an assumption has been used
in many fields of finance: building optimal portfolio, pricing and hedging derivatives and
managing risks. However, real financial data tend to exhibit extreme price changes such as
stock market crashes that seem incompatible with the assumption of normality. This article
shows how extreme value theory can be useful to know more precisely the characteristics of
the distribution of asset returns and finally help to chose a better model by focusing on the
tails of the distribution. An empirical analysis using equity data of the US market is provided
to illustrate this point.


THE MARKET PREMIUM FOR DYNAMIC TAIL RISK BY LORAN
CHOLLETE AND CHING-CHIH LU

The likelihood of systemic risk presents a challenge for modern finance. In particular, it is
important to know to what extent the market exacts a premium for exposure to tail risk in
asset returns. In this paper, we use a simple estimate of dynamic tail risk in returns, and
measure its performance in a Fama and French (1993) style factor model. Empirically, tail
risk induces a monotonic pattern: stocks that are more sensitive to tail risk receive higher
returns. Somewhat surprisingly, tail risk does not affect financial firms more than other firms.
Tail risk exhibits relatively large returns and has very low correlations with other risk factors,
suggesting that it may represent a quite different type of risk. We document an economically
and statistically significant premium between 1% and 3% for tail risk, which is robust to size,
book-to-market, liquidity, downside risk, volatility and momentum. Furthermore, when we
consider asset pricing tests, the only model to survive is one that augments the standard
Fama- French model with a tail risk factor. Our results suggest that financial markets can
recognize tail risk, which is reflected in the cross section of stock returns.





LIMITATION OF THE STUDY:
1. This study mainly depends upon the secondary data,
2. The data of the company is analysed only for five years.
3. The reliability of the study depends upon the accuracy of the data