Capturing downside risk in financial markets: the case of the Asian Crisis

Using data on Asian equity markets, we observe that during periods of finan cial turmoil, deviations from the mean-variance framework become more sever e, resulting in periods with additional downside risk to investors. Current risk management techniques failing to take this additional downside risk i nto account will underestimate the true Value-at-Risk with greater severity during periods of financial turnoil. We provide a conditional approach to the Value-at-Risk methodology, known as conditional VaR-x, which to capture the time variation of non-normalities allows for additional tail fatness i n the distribution of expected returns. These conditional VaR-x estimates a re then compared to those based on the RiskMetrics(TM) methodology from J.P . Morgan, where we fmd that the model provides improved forecasts of the Va lue-at-Risk. We are therefore able to show that our conditional VaR-x estim ates are better able to capture the nature of downside risk, particularly c rucial in times of financial crises. (C) 1999 Elsevier Science Ltd. All rig hts reserved.