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A Semiparametric Approach to Value-at-Risk, Expected Shortfall and Optimum Asset Allocation in Stock-Bond Portfolios

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  • Xiangjin B. Chen

    ()

  • Param Silvapulle

    ()

  • Mervyn Silvapulle

    ()

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    Abstract

    This paper investigates stock-bond portfolios’ tail risks such as value-at-risk (VaR) and expected shortfall (ES), and the way in which these measures have been affected by the global financial crisis. The semiparametric t-copula is found to be adequate for modelling stock-bond joint distributions of G7 countries and Australia. Empirical results show that weak (negative) dependence has increased for seven countries after the crisis, while it has decreased for Italy. However, both VaR and ES have increased for all eight countries. Before the crisis, the minimum portfolio VaR and ES were achieved at an interior solution only for the US, the UK, Australia, Canada and Italy. After the crisis, the corner solution was found for all eight countries. Evidence of “flight to quality†and “safety first†investor behaviour was found to be strong, after the global financial crisis. The semiparametric t-copula adequately forecasts the outer-sample VaR. These findings have implications for global financial regulators and the Basel Committee, whose central focus is currently on increasing the capital requirements as a consequence of the recent global financial crisis.

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    File URL: http://www.buseco.monash.edu.au/ebs/pubs/wpapers/2013/wp14-13.pdf
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    Bibliographic Info

    Paper provided by Monash University, Department of Econometrics and Business Statistics in its series Monash Econometrics and Business Statistics Working Papers with number 14/13.

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    Date of creation: 2013
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    Handle: RePEc:msh:ebswps:2013-14

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    Web: http://www.buseco.monash.edu.au/depts/ebs/pubs/wpapers/

    Related research

    Keywords: Copula; Semiparametric method; Value-at-Risk; Investment decision;

    This paper has been announced in the following NEP Reports:

    References

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    1. 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.
    2. Hyung, Namwon & de Vries, Casper G., 2007. "Portfolio selection with heavy tails," Journal of Empirical Finance, Elsevier, vol. 14(3), pages 383-400, June.
    3. Gunky Kim & Mervyn J. Silvapulle & Paramsothy Silvapulle, 2007. "Estimating the Error Distribution in the Multivariate Heteroscedastic Time Series Models," Monash Econometrics and Business Statistics Working Papers 8/07, Monash University, Department of Econometrics and Business Statistics.
    4. 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.
    5. Scruggs, John T. & Glabadanidis, Paskalis, 2003. "Risk Premia and the Dynamic Covariance between Stock and Bond Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(02), pages 295-316, June.
    6. Jansen, Dennis W. & Koedijk, Kees G. & de Vries, Casper G., 2000. "Portfolio selection with limited downside risk," Journal of Empirical Finance, Elsevier, vol. 7(3-4), pages 247-269, November.
    7. Lorenzo Cappiello & Robert F. Engle & Kevin Sheppard, 2006. "Asymmetric Dynamics in the Correlations of Global Equity and Bond Returns," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 4(4), pages 537-572.
    8. Kim, Gunky & Silvapulle, Mervyn J. & Silvapulle, Paramsothy, 2007. "Comparison of semiparametric and parametric methods for estimating copulas," Computational Statistics & Data Analysis, Elsevier, vol. 51(6), pages 2836-2850, March.
    9. Connolly, Robert & Stivers, Chris & Sun, Licheng, 2005. "Stock Market Uncertainty and the Stock-Bond Return Relation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 40(01), pages 161-194, March.
    10. Philippe Artzner & Freddy Delbaen & Jean-Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228.
    11. Fleming, Jeff & Kirby, Chris & Ostdiek, Barbara, 1998. "Information and volatility linkages in the stock, bond, and money markets," Journal of Financial Economics, Elsevier, vol. 49(1), pages 111-137, July.
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