How does the Brexit vote affect tail risk? An extreme value approach for the UK financial markets

Abstract We study the impact of the Brexit vote on tail risk in the UK financial markets. To this end, we estimate a widely used measure of risk, the Value at Risk, as an indicator of tail risk. We use extreme value theory, based on the peaks-over-threshold method, to model the extremes over a high threshold before and after the UK’s momentous decision to leave the European Union employing non-parametric and semi-parametric estimation techniques. We apply a bias-corrected method to reduce small sample estimation bias through a non-parametric bootstrap simulation. For the analysis, we focus on the FTSE-100 index, the GBP/EUR exchange rate, the Treasury Gilt, and nine credit default swaps of the most important industry sectors. The findings suggest that the new structure of downside tail risk -either frequency or magnitude- associated with large losses is not higher than its pre-Brexit levels. However empirical evidence suggests that the upside-tail estimates (i.e., the likelihood of large profits) have now decreased.