Marking systemic portfolio risk with the Merton model

Marking systemic portfolio risk with the Merton model

It has been argued that one of the factors that triggered the downfall of Long-Term Capital Management (LTCM) was its failure to properly incorporate fat tails of asset price distributions into investment decisions as well as risk management (Lowenstein, 2000). Today, financial institutions systematically deduce fat tails from the option markets and incorporate this information consistently into the pricing as well as the risk management framework.

Despite this progress, it is interesting to

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