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Improved Cash Flow Map
Apr 1, 1999
In the RiskMetrics methodology, a portfolio of financial instruments is broken down into a number of cash flows, each occurring at a particular time. This leads to an unmanageable number of combinations of cashflow dates when many financial instruments are considered.
To avoid an intractable number of correlations and volatilities in the VaR calculation, the RiskMetrics methodology simplifies the time structure by mapping each cash flow to a pre-specified set of RiskMetrics vertices.
In the next section, we present the current RiskMetrics cash flow mapping methodology which works well under most circumstances, but was recently found to produce undesirable results under extreme vertex volatility and correlation scenarios. Then, we present a simple alternative that preserves most of its properties and behaves well under extreme circumstances. The last section summarizes our findings.
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