Portfolio optimization in the presence of dependent financial returns with long memory: A copula based approach
In this paper, we seek to examine the effect of the presence of long memory on the dependence structure between financial returns and on portfolio optimization. First, we focus on the dependence structure using copulas. To select the best copula, in addition to the goodness of fit tests, we employ a graphical method based on visual comparison of the fitted copula density and the smoothed copula density estimated by wavelets. Moreover, we check the stability of the copula parameter. The empirical results show that the long memory affects the dependence structure. Second, we analyze the impact of this dependence structure on the optimal portfolio. We propose a new approach based on minimizing the Conditional Value at Risk and assuming that the dependence structure is modeled by the copula parameter. The empirical results show that our approach outperforms the traditional minimizing variance approach, where the dependence structure is represented by the linear correlation coefficient.
If 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.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
References listed on IDEAS
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.:
- P. Hartmann & S. Straetmans & C.G. de Vries, 2001.
"Asset Market Linkages in Crisis Periods,"
Tinbergen Institute Discussion Papers
01-071/2, Tinbergen Institute.
- de Vries, Casper G & Hartmann, Philipp & Straetmans, Stefan, 2001. "Asset Market Linkages in Crisis Periods," CEPR Discussion Papers 2916, C.E.P.R. Discussion Papers.
- Hartmann, P. & Straetmans, S. & De Vries, C.G., 2001. "Asset Market Linkages in Crisis Periods," Papers 71, Quebec a Montreal - Recherche en gestion.
- Hartmann, Philipp & Straetmans, Stefan & de Vries, Casper, 2001. "Asset market linkages in crisis periods," Working Paper Series 0071, European Central Bank.
- Philipp Hartman & Stefan Straetmans & Casper De Vries, 2001. "Asset market linkages in crisis periods," Proceedings 727, Federal Reserve Bank of Chicago.
- I.N. Lobato & N.E. Savin, 1996.
"Real and Spurious Long Memory Properties of Stock Market Data,"
9605004, EconWPA, revised 26 Sep 1996.
- Lobato, Ignacio N & Savin, N E, 1998. "Real and Spurious Long-Memory Properties of Stock-Market Data," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(3), pages 261-268, July.
- Lobato, I.N. & Savin, N.E., 1996. "Real and Spurious Long Memory Properties of Stock Market Data," Working Papers 96-07, University of Iowa, Department of Economics.
- 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.
- Aloui, Riadh & Aïssa, Mohamed Safouane Ben & Nguyen, Duc Khuong, 2011.
"Global financial crisis, extreme interdependences, and contagion effects: The role of economic structure?,"
Journal of Banking & Finance,
Elsevier, vol. 35(1), pages 130-141, January.
- Riadh Aloui & Mohamed Safouane Ben Aissa & Khuong Nguyen Duc, 2010. "Global Financial Crisis, Extreme Interdependences, and Contagion E§ects: The Role of Economic Structure," Working Papers 15, Development and Policies Research Center (DEPOCEN), Vietnam.
- Beine, Michel, 2004.
"Conditional covariances and direct central bank interventions in the foreign exchange markets,"
Journal of Banking & Finance,
Elsevier, vol. 28(6), pages 1385-1411, June.
- Michel Beine, 2004. "Conditional covariance and direct Central Bank intervention in the foreign exchange markets," ULB Institutional Repository 2013/10431, ULB -- Universite Libre de Bruxelles.
- Christian Genest & Jean-François Quessy & Bruno Rémillard, 2006. "Goodness-of-fit Procedures for Copula Models Based on the Probability Integral Transformation," Scandinavian Journal of Statistics, Danish Society for Theoretical Statistics;Finnish Statistical Society;Norwegian Statistical Association;Swedish Statistical Association, vol. 33(2), pages 337-366.
- 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.
- Andrew J. Patton, 2002. "On the out-of-sample importance of skewness and asymetric dependence for asset allocation," LSE Research Online Documents on Economics 24951, London School of Economics and Political Science, LSE Library.
- Post, G.T. & van Vliet, P., 2004. "Conditional Downside Risk and the CAPM," ERIM Report Series Research in Management ERS-2004-048-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
- Chris Brooks & Simon P. Burke & Gita Persand, 2002.
"Augoregressive Conditional Kurtosis,"
ICMA Centre Discussion Papers in Finance
icma-dp2002-05, Henley Business School, Reading University.
- Andrew Ang & Joseph Chen & Yuhang Xing, 2005.
NBER Working Papers
11824, National Bureau of Economic Research, Inc.
- Genest, Christian & Masiello, Esterina & Tribouley, Karine, 2009. "Estimating copula densities through wavelets," Insurance: Mathematics and Economics, Elsevier, vol. 44(2), pages 170-181, April.
- Susmel, Raul, 2001. "Extreme observations and diversification in Latin American emerging equity markets," Journal of International Money and Finance, Elsevier, vol. 20(7), pages 971-986, December.
- Garcia, René & Tsafack, Georges, 2011.
"Dependence structure and extreme comovements in international equity and bond markets,"
Journal of Banking & Finance,
Elsevier, vol. 35(8), pages 1954-1970, August.
- René Garcia & Georges Tsafack, 2009. "Dependence Structure and Extreme Comovements in International Equity and Bond Markets," CIRANO Working Papers 2009s-21, CIRANO.
- Harvey, Campbell R. & Siddique, Akhtar, 1999. "Autoregressive Conditional Skewness," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 34(04), pages 465-487, December.
- Mesfioui, Mhamed & Quessy, Jean-Francois, 2005. "Bounds on the value-at-risk for the sum of possibly dependent risks," Insurance: Mathematics and Economics, Elsevier, vol. 37(1), pages 135-151, August.
- Giacomini, Enzo & HÃ¤rdle, Wolfgang & Spokoiny, Vladimir, 2009.
"Inhomogeneous Dependence Modeling with Time-Varying Copulae,"
Journal of Business & Economic Statistics,
American Statistical Association, vol. 27(2), pages 224-234.
- Enzo Giacomini & Wolfgang Härdle & Ekaterina Ignatieva & Vladimir Spokoiny, 2006. "Inhomogeneous Dependency Modelling with Time Varying Copulae," SFB 649 Discussion Papers SFB649DP2006-075, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
- Das, Sanjiv Ranjan & Uppal, Raman, 2002.
"Systemic Risk and International Portfolio Choice,"
CEPR Discussion Papers
3305, C.E.P.R. Discussion Papers.
- Engle, Robert, 2002. "Dynamic Conditional Correlation: A Simple Class of Multivariate Generalized Autoregressive Conditional Heteroskedasticity Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(3), pages 339-350, July.
- Gilboa,Itzhak, 2009.
"Theory of Decision under Uncertainty,"
Cambridge University Press, number 9780521741231, December.
- Arzac, Enrique R. & Bawa, Vijay S., 1977. "Portfolio choice and equilibrium in capital markets with safety-first investors," Journal of Financial Economics, Elsevier, vol. 4(3), pages 277-288, May.
- 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.
- Wei Sun & Svetlozar Rachev & Frank Fabozzi & Petko Kalev, 2009. "A new approach to modeling co-movement of international equity markets: evidence of unconditional copula-based simulation of tail dependence," Empirical Economics, Springer, vol. 36(1), pages 201-229, February.
- de Melo Mendes, Beatriz Vaz & Kolev, Nikolai, 2008. "How long memory in volatility affects true dependence structure," International Review of Financial Analysis, Elsevier, vol. 17(5), pages 1070-1086, December.
- Sadique, Shibley & Silvapulle, Param, 2001. "Long-Term Memory in Stock Market Returns: International Evidence," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 6(1), pages 59-67, January.
- Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
- François Longin, 2001. "Extreme Correlation of International Equity Markets," Journal of Finance, American Finance Association, vol. 56(2), pages 649-676, 04.
- Katja Ignatieva & Eckhard Platen, 2009.
"Modelling Co-movements and Tail Dependency in the International Stock Market via Copulae,"
Research Paper Series
265, Quantitative Finance Research Centre, University of Technology, Sydney.
- Katja Ignatieva & Eckhard Platen, 2010. "Modelling Co-movements and Tail Dependency in the International Stock Market via Copulae," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 17(3), pages 261-302, September.
- Baillie, Richard T. & Bollerslev, Tim & Mikkelsen, Hans Ole, 1996.
"Fractionally integrated generalized autoregressive conditional heteroskedasticity,"
Journal of Econometrics,
Elsevier, vol. 74(1), pages 3-30, September.
- Tom Doan, "undated". "RATS programs to replicate Baillie, Bollerslev, Mikkelson FIGARCH results," Statistical Software Components RTZ00009, Boston College Department of Economics.
- Li, Xiao-Ming, 2011. "How do exchange rates co-move? A study on the currencies of five inflation-targeting countries," Journal of Banking & Finance, Elsevier, vol. 35(2), pages 418-429, February.
- Chollete, Lorán & de la Peña, Victor & Lu, Ching-Chih, 2011. "International diversification: A copula approach," Journal of Banking & Finance, Elsevier, vol. 35(2), pages 403-417, February.
- Annalisa Di Clemente & Claudio Romano, 2004. "Measuring and Optimizing Portfolio Credit Risk: A Copula-based Approach," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 33(3), pages 325-357, November.
- Ang, Andrew & Chen, Joseph, 2002. "Asymmetric correlations of equity portfolios," Journal of Financial Economics, Elsevier, vol. 63(3), pages 443-494, March.
- 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.
- Philippe Artzner & Freddy Delbaen & Jean-Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228.
- Jondeau, Eric & Rockinger, Michael, 2003. "Conditional volatility, skewness, and kurtosis: existence, persistence, and comovements," Journal of Economic Dynamics and Control, Elsevier, vol. 27(10), pages 1699-1737, August.
- Manner Hans, 2007. "Estimation and Model Selection of Copulas with an Application to Exchange Rates," Research Memorandum 056, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
- Bouye, Eric & Durlleman, Valdo & Nikeghbali, Ashkan & Riboulet, Gaël & Roncalli, Thierry, 2000. "Copulas for finance," MPRA Paper 37359, University Library of Munich, Germany.
- Bollerslev, Tim, 1990. "Modelling the Coherence in Short-run Nominal Exchange Rates: A Multivariate Generalized ARCH Model," The Review of Economics and Statistics, MIT Press, vol. 72(3), pages 498-505, August.
- Ling Hu, 2006. "Dependence patterns across financial markets: a mixed copula approach," Applied Financial Economics, Taylor & Francis Journals, vol. 16(10), pages 717-729.
- Fermanian, Jean-David, 2005. "Goodness-of-fit tests for copulas," Journal of Multivariate Analysis, Elsevier, vol. 95(1), pages 119-152, July.
- Rodriguez, Juan Carlos, 2007. "Measuring financial contagion: A Copula approach," Journal of Empirical Finance, Elsevier, vol. 14(3), pages 401-423, June.
- Quaranta, Anna Grazia & Zaffaroni, Alberto, 2008. "Robust optimization of conditional value at risk and portfolio selection," Journal of Banking & Finance, Elsevier, vol. 32(10), pages 2046-2056, October.
- Rockafellar, R. Tyrrell & Uryasev, Stanislav, 2002. "Conditional value-at-risk for general loss distributions," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1443-1471, July.
When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:37:y:2013:i:2:p:361-377. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu)
If references are entirely missing, you can add them using this form.