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Extreme Events and Portfolio Construction [2]

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Bullet points include: Taking due account of the possibility of extreme events occurring is important but also challenging for many market professionals. Insurers: Solvency II. Mandates 1 in 200 year VaR, but we do not have 200 years of relevant historical data. IORPs: Holistic Balance Sheets. Can depend heavily on hopefully rare extreme credit events, e.g. a sponsor or a national pension protection scheme defaulting. Banks: E.g. operational risk management: many recent losses much larger than previously modelled (effective) upper limits. Allowing for them in portfolio construction is particularly challenging. Need to balance risk versus reward, making it important to understand causes of extreme events and to avoid giving them too much emphasis

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