13.4 Computational experiments
Two separate computational studies were undertaken. The first covers the period in
January 2008 when equity markets were starting to decline (component stocks of the
EURO STOXX 50 index are considered). The second study covers a period in Septem-
ber 2008 when the global economy was beginning to move into recession (component
stocks of the Dow Jones 30 are considered).
13.4.1 Study I
The first study covers the period January 17, 2008 to January 23, 2008 when sentiment
worsened and option-implied volatility measures surged. Over this period worldwide
stock markets fell significantly. Since 2003 equity markets had been growing steadily,
but at the end of 2007 they started to decline and sentiment started to fall. Over January
2008 market sentiment worsened further. This was driven by a few key events. In the US,
George Bush announced a stimulus plan for the economy and the Fed cut interest rates
by 75 basis points, the largest cut since October 1984. In Europe, Socie ́te ́Ge ́ne ́rale was
hit by the fraud scandal of alleged rogue trader Jerome Kerviel. In Asia, stock markets
also fell in this period.
We consider a portfolio of financial stocks weighted by their market capitalizations.
The portfolio constituents and weights are shown in Table 13.1. Table 13.2 shows the
volatility values for this portfolio. The second column shows the values predicted by the
‘‘basic’’ factor model, the third the values from the model updated using only option-
implied volatility data (q¼1), the fourth the values from the model updated using a
Equity portfolio risk estimation using market information and sentiment 297Table 13.1.Constituents and weighting factors for
the portfolio of financial stocks (out of the EURO
STOXX 50)Company name Weighting factor
(%)ALLIANZ 8.30
GENERALI 5.60
AXA 6.80
BBVA 7.10
BANCO SANTANDER 10.40
BNP PARIBAS 8.50
CREDIT AGRICOLE 4.60
DEUTSCHE BANK 5.50
DEUTSCHE BOERSE 3.00
SOCIETE GENERALE 5.60
IBERDROLA 6.50
ING GROEP 7.20
INTESA SANPAOLO 7.70
MUENCHENER RUCK 3.60
UNICREDIT 9.60