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Recovering copulas from limited information and an application to asset allocation

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  • Chu, Ba
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    Abstract

    This paper proposes an entropy-based method to construct a new class of copulas - the most entropic canonical copulas (MECC). Our empirical study focuses on an investment problem for an investor with a constant relative risk aversion (CRRA) utility function allocating wealth between the Dow Jones Large-Cap and Small-Cap indices, of which the contemporaneous dependence can be modeled by the MECC or other commonly-used copulas. Both the theoretical analysis of the method and the empirical study indicate the potential for enormous statistical and economic gains as a result of using the MECC.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0378426610004589
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 35 (2011)
    Issue (Month): 7 (July)
    Pages: 1824-1842

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    Handle: RePEc:eee:jbfina:v:35:y:2011:i:7:p:1824-1842

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Shannon entropy Most entropic copulas The Kullback-Leibler cross entropy Rank correlations CRRA utility functions;

    References

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    Cited by:
    1. Massimo Guidolin & Stuart Hyde, 2011. "Can VAR Models Capture Regime Shifts in Asset Returns? A Long-Horizon Strategic Asset Allocation Perspective," Working Papers 414, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    2. Auer, Benjamin R. & Schuhmacher, Frank, 2013. "Robust evidence on the similarity of Sharpe ratio and drawdown-based hedge fund performance rankings," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 24(C), pages 153-165.
    3. Ba Chu, 2012. "Approximation of Asymmetric Multivariate Return Distributions," Asia-Pacific Financial Markets, Springer, vol. 19(3), pages 293-318, September.

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