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Marginals versus copulas: Which account for more model risk in multivariate risk forecasting?

Author

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  • Fritzsch, Simon
  • Timphus, Maike
  • Weiß, Gregor

Abstract

We study the model risk of multivariate risk models in a comprehensive empirical study on Copula-GARCH models used for forecasting Value-at-Risk and Expected Shortfall. To determine whether model risk inherent in the forecasting of portfolio risk is caused by the candidate marginal or copula models, we analyze different groups of models in which we fix either the marginals, the copula, or neither. Model risk is economically significant, especially high during periods of crisis, and almost completely due to the choice of the copula. We then propose the use of the model confidence set procedure to narrow down the set of available models and reduce model risk for Copula-GARCH risk models. Our proposed approach leads to a significant reduction of the model risk of one day ahead forecasts by our various candidate risk models.

Suggested Citation

  • Fritzsch, Simon & Timphus, Maike & Weiß, Gregor, 2024. "Marginals versus copulas: Which account for more model risk in multivariate risk forecasting?," Journal of Banking & Finance, Elsevier, vol. 158(C).
    • Handle: RePEc:eee:jbfina:v:158:y:2024:i:c:s0378426623002261
    DOI: 10.1016/j.jbankfin.2023.107035
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    More about this item

    Keywords

    Portfolio risk; Model risk; Risk forecasting; Copulas;
    All these keywords.

    JEL classification:

    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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