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Comparing Variance/Covariance and Historical Simulation in the Context of the Financial Crisis – Do Extreme Movements Have an Influence onto Portfolio Selection?

Keywords: Portfolio theory , financial crisis , historical simulation , variance/covariance approach

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Abstract:

Portfolio theory and the basic ideas of Markowitz have been extended in the recent past by alternative risk models as historical simulation or even copula functions. The central question of this paper is if these approaches lead to different results compared to the classical variance/covariance approach. Therefore, empirical data of the last 10 years is analysed. Both approaches are compared in the special context of the financial crisis. The worst case optimization and the Value at Risk (VaR) are defined in order to define the minimum risk portfolio before and after the financial crisis. The result is that the financial crisis has nearly no impact onto the portfolio, but the two approaches lead to different results.

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