Basel II and the Risk Management of Basket Options with Time-Varying
by Amy S. K. Wong
Tinbergen Institute, Erasmus University Rotterdam
The impact of jumps, regime switches, and linearly changing correlation term
structures on the risk management of basket options has been examined in this
paper. First, the results show that there is an asymmetric correlation effect
on the value-at-risk of basket options. Second, the time at which a correlation
shock occurs during the life of an option is particularly important for hedged
basket options. Finally, the square-rootof- time rule can lead to severe
underestimation of value-at-risk for basket options with time-varying
correlations for some cases, even by a factor exceeding the minimum
regulatory stress factor.
JEL Codes: G15, G21.
(PDF, 31 pages 386 kb)