Tail-driven portfolios: Unveiling financial contagion and enhancing risk management

Abstract

In financial markets, tail risks, representing the potential for substantial losses, bear significant implications for the formulation of effective risk management strategies. Yet, there exists a notable gap in understanding the interconnectedness within the global market, particularly when analysing time-series tail data. This study introduces a reliable method for identifying events indicative of tail transitions in financial time-series data. The investigation suggests consistent patterns governing extreme events across diverse industries and different time periods, suggestive of the financial contagion in tail risks. Importantly, time-series tail slopes in specific stocks emerge as viable predictors of price fluctuations in others. These findings offer valuable insights for portfolio diversification and risk mitigation in the interconnected financial market.