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Modeling International Financial Returns with a Multivariate Regime Switching Copula

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Author Info
Chollete, Loran
Heinen, Andreas
Valdesogo, Alfonso

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Abstract

In order to capture observed asymmetric dependence in international financial returns, we construct a multivariate regime-switching model of copulas. We model dependence with one Gaussian and one canonical vine copula regime. Canonical vines are constructed from bivariate conditional copulas and provide a very flexible way of characterizing dependence in multivariate settings. We apply the model to returns from the G5 and Latin American regions, and document two main findings. First, we discover that models with canonical vines generally dominate alternative dependence structures. Second, the choice of copula is important for risk management, because it modifies the Value at Risk (VaR) of international portfolio returns.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 8114.

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Date of creation: Feb 2008
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Handle: RePEc:pra:mprapa:8114

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Related research
Keywords: Asymmetric dependence Canonical vine copula International returns Regime-Switching Risk Management Value-at-Risk.

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Find related papers by JEL classification:
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models
G1 - Financial Economics - - General Financial Markets
C35 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Discrete Regression and Qualitative Choice Models

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  15. Tim Bollerslev & Jeffrey Wooldridge, 1992. "Quasi-maximum likelihood estimation and inference in dynamic models with time-varying covariances," Econometric Reviews, Taylor and Francis Journals, vol. 11(2), pages 143-172. [Downloadable!] (restricted)
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  17. Berkowitz, Jeremy, 2001. "Testing Density Forecasts, with Applications to Risk Management," Journal of Business & Economic Statistics, American Statistical Association, vol. 19(4), pages 465-74, October.
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