How to extend the RiskMetrics market risk universe

Abstract

RiskMetrics™ (RM) represents a framework for measuring market risk founded on the Value at Risk concept, and offer daily updated estimates of standard deviations and correlations of the assets within their market risk universe. Unfortunately, a company may also be exposed to other sources of market risk than the ones covered by RM. This paper shows how to extend the RM universe in a consistent way. The main challenge is to obtain the correlations between each pair of RM asset and additional asset. Simple rules apply for updating estimates of the extended universe for new daily information.