Asset Pair-Copula Selection with Downside Risk Minimization
AbstractCopulae provide investors with tools to model the dependency structure among financial products. The choice of copulae plays an important role in successful copula applications. However, selecting copulae usually relies on general goodness-of-fit (GoF) tests which are independent of the particular financial problem. This paper ¯rst proposes a pair-copula-GARCH model to construct the dependency structure and simulate the joint returns of five U.S. equites. It then discusses copula selection problem from the perspective of downside risk management with the so-called D-vine structure, which considers the Joe-Clayton copula and the Student t copula as building blocks for the vine pair-copula decomposition. Value at risk, expected shortfall, and Omega function are considered as downside risk measures in this study. As an alternative to the traditional bootstrap approaches, the proposed pair-copula-GARCH model provides simulated asset returns for generating future scenarios of portfolio value. It is found that, although the Student t pair-copula system performs better than the Joe-Clayton system in a GoF test, the latter is able to provide the loss distributions which are more consistent with the empirically examined loss distributions while optimizing the Omega ratio. Furthermore, the economic benefit of using the pair-copula-GARCH model is revealed by comparing the loss distributions from the proposed model and the conventional exponentially weighted moving average model of RiskMetrics in this case.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by COMISEF in its series Working Papers with number 037.
Length: 35 pages
Date of creation: 17 May 2010
Date of revision:
Contact details of provider:
Web page: http://www.comisef.eu
Downside Risk; AR-TGARCH; Pair-Copula; Vine Structure; Differential Evolution;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-05-29 (All new papers)
- NEP-ECM-2010-05-29 (Econometrics)
- NEP-RMG-2010-05-29 (Risk Management)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Lawrence R. Glosten & Ravi Jagannathan & David E. Runkle, 1993.
"On the relation between the expected value and the volatility of the nominal excess return on stocks,"
157, Federal Reserve Bank of Minneapolis.
- Glosten, Lawrence R & Jagannathan, Ravi & Runkle, David E, 1993. " On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks," Journal of Finance, American Finance Association, vol. 48(5), pages 1779-1801, December.
- Andrew J. Patton, 2006.
"Modelling Asymmetric Exchange Rate Dependence,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(2), pages 527-556, 05.
- Andrew J. Patton, 2004. "On the Out-of-Sample Importance of Skewness and Asymmetric Dependence for Asset Allocation," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 2(1), pages 130-168.
- Christos Floros, 2007. "The use of GARCH models for the calculation of minimum capital risk requirements: International evidence," International Journal of Managerial Finance, Emerald Group Publishing, vol. 3(4), pages 360-371, October.
- M. Gilli & E. Kellezi & H. Hysi, 2006.
"A Data-Driven Optimization Heuristic for Downside Risk Minimization,"
Computing in Economics and Finance 2006
355, Society for Computational Economics.
- Manfred Gilli & Evis Këllezi & Hilda Hysi, . "A Data-Driven Optimization Heuristic for Downside Risk Minimization," Swiss Finance Institute Research Paper Series 06-02, Swiss Finance Institute.
- Genest, Christian & Rémillard, Bruno & Beaudoin, David, 2009. "Goodness-of-fit tests for copulas: A review and a power study," Insurance: Mathematics and Economics, Elsevier, vol. 44(2), pages 199-213, April.
- Andrew Ang & Geert Bekaert, 2002. "International Asset Allocation With Regime Shifts," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1137-1187.
- Fantazzini, Dean, 2010. "Three-stage semi-parametric estimation of T-copulas: Asymptotics, finite-sample properties and computational aspects," Computational Statistics & Data Analysis, Elsevier, vol. 54(11), pages 2562-2579, November.
- Rabemananjara, R & Zakoian, J M, 1993. "Threshold Arch Models and Asymmetries in Volatility," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 8(1), pages 31-49, Jan.-Marc.
- Jondeau, Eric & Rockinger, Michael, 2006. "The Copula-GARCH model of conditional dependencies: An international stock market application," Journal of International Money and Finance, Elsevier, vol. 25(5), pages 827-853, August.
- Bjorn Hansson & Peter Hordahl, 1998. "Testing the conditional CAPM using multivariate GARCH-M," Applied Financial Economics, Taylor and Francis Journals, vol. 8(4), pages 377-388.
- Manuel Ammann & Stephan Suss, 2009. "Asymmetric dependence patterns in financial time series," European Journal of Finance, Taylor and Francis Journals, vol. 15(7-8), pages 703-719.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Anil Khuman).
If references are entirely missing, you can add them using this form.