Modeling Dependencies in Finance using Copulae

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Modeling Dependencies in Finance using Copulae

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Wolfgang Härdle
Ostap Okhrin
Yarema Okhrin

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Abstract

In this paper we provide a review of copula theory with applications to finance. We illustrate the idea on the bivariate framework and discuss the simple, elliptical and Archimedean classes of copulae. Since the cop- ulae model the dependency structure between random variables, next we explain the link between the copulae and common dependency measures, such as Kendall's tau and Spearman's rho. In the next section the copulae are generalized to the multivariate case. In this general setup we discuss and provide an intensive literature review of estimation and simulation techniques. Separate section is devoted to the goodness-of-fit tests. The importance of copulae in finance we illustrate on the example of asset allocation problems, Value-at-Risk and time series models. The paper is complemented with an extensive simulation study and an application to financial data.

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Publisher Info
Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2008-043.

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Length: 38 pages
Date of creation: Jun 2008
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Handle: RePEc:hum:wpaper:sfb649dp2008-043

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Find related papers by JEL classification:
C00 - Mathematical and Quantitative Methods - - General - - - General
C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Semiparametric and Nonparametric Methods
C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

This paper has been announced in the following NEP Reports:

NEP-ALL-2008-06-27 (All new papers)
NEP-ECM-2008-06-27 (Econometrics)
NEP-RMG-2008-06-27 (Risk Management)

Cited by:
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Xu, Wei & Filler, Guenther & Odening, Martin & Okhrin, Ostap, 2009. "On the Systemic Nature of Weather Risk," 2009 Annual Meeting, July 26-28, 2009, Milwaukee, Wisconsin 49131, Agricultural and Applied Economics Association. [Downloadable!]
Other versions:
- Guenther Filler & Martin Odening & Ostap Okhrin & Wei Xu, 2009. "On the Systemic Nature of Weather Risk," SFB 649 Discussion Papers SFB649DP2009-002, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany. [Downloadable!]

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This page was last updated on 2009-12-3.

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