The Unholy Trinity: Fat Tails, Tail Dependence, and Micro-Correlations

Climate Change and Risk Management: Challenges for Insurance, Adaptation, and Loss Estimation

Executive Summary Adapting to climate change will not only require responding to the physical effects of global warming, but will also require adapting the way we conceptualize, measure, and manage risks. Climate change is creating new risks, altering the risks we already face, and also, importantly, impacting the interdependencies between these risks. In this paper we focus on three particular...

Beyond Correlations : The Use and Abuse of Copulas in Economic Capital Calculations

Despite extensive literature consisting of many excellent academic and practical papers, there are still many commonly heard fallacies in practice such as: “To aggregate risks, all I need are correlations”. “I assume dependence/independence, hence there is no copula”. “I need to use a Variance-Covariance approach with tail-end correlations to capture fat tails and tail dependence”. “The mere ex...

The Limits of Securitization on a Hot, Flat Planet1 Micro-correlations, Fat Tails and Tail Dependence

Aggregation is a key feature of traditional risk management strategies. Financial institutions securitize assets and property insurers hold bundles of policies across many lines of business. With independent assets and risks with thin tails, the law of large numbers (LLN) and the central limit theorem (CLT) assure risk benefits from aggregation: the standard deviation of the sum increases slowe...

A General Approach to Integrated Risk Management with Skewed, Fat-tailed Risk

The goal of integrated risk management in a financial institution is to measure and manage risk and capital across a range of diverse business activities. This requires an approach for aggregating risk types (market, credit, and operational) whose distributional shapes vary considerably. In this paper, we use the method of copulas to construct the joint risk distribution for a typical large, in...

Supervenience, Emergence, and Epiphenomenalism: Physicalism’s Unholy Trinity