Hedging the Black Swan: Conditional Heteroskedasticity and Tail Dependence in S&P500 and VIX

The recent financial crisis has accentuated the fact that extreme outcomes have been overlookedand not dealt with adequately. While extreme value theories have existed for a long time, themultivariate variant is difficult to handle in the financial markets due to the prevalentheteroskedasticity embedded in most financial time series, and the complex extremal dependencethat cannot be conveniently captured by a single structure. Moreover, most of the existingapproaches are based on a limiting argument in which all variables become large at the same rate.In this paper, we show how the conditional approach of Heffernan and Tawn (2004) can beimplemented to model extremal dependence between financial time series....