Risk Modeling modern style is all about 'Predicting Instability'.
A "Black Swan", an event that is rare and difficult to predict, which could reflect either a sudden and large shift in the variance or the mean of a random variable. A large shift in the mean or the variance of a random variable would mean an observation falling in the tails of the distribution.We would assume that a Black Swan is a large and a sudden change in the second moment. That is a rare and highly improbable large change in the conditional variance of relevant macroeconomic data.
The test statistics that are available to quality control engineers entail an interrogation of the real time data as they are observed; they sound alarm bells when the moments shift suddenly with high probability.
'Predicting Instability' provides a framework based on a statistic for the Sample Generalized Variance, which is useful for interrogating real time data and to predicting statistically significant sudden and large shifts in the conditional variance of a vector of correlated macroeconomic variables. Central banks can incorporate the framework in the policy making process.
Download: Predicting Instability
source: MPRA
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