Long Term Skewness and Systemic Risk
Financial risk management has generally focused on short term risks rather than long term risks and arguably this is an important component of the current financial crisis. Econometric approaches to measuring long term risk are investigated by testing for measures of long term skewness associated with asymmetric volatility models. This skewness in a market factor leads to default correlations even far in the future. Investors concerned about long term risks can hedge exposure as in the ICAPM. Such hedging will affect asset prices and can be tested directly with volatility models. Using estimates from VLAB, evidence is found for several types of hedge portfolios including volatility, long bonds, term spread, credit spread and gold.