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Structure and estimation of Lévy subordinated hierarchical Archimedean copulas (LSHAC): Theory and empirical tests

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  • Zhu, Wenjun
  • Wang, Chou-Wen
  • Tan, Ken Seng

Abstract

Lévy subordinated hierarchical Archimedean copulas (LSHAC) are flexible models in high dimensional modeling. However, there is limited literature discussing their applications, largely due to the challenges in estimating their structures and their parameters. In this paper, we propose a three-stage estimation procedure to determine the hierarchical structure and the parameters of a LSHAC. This is the first paper to empirically examine the modeling performances of LSHAC models using exchange traded funds. Simulation study demonstrates the reliability and robustness of the proposed estimation method in determining the optimal structure. Empirical analysis further shows that, compared to elliptical copulas, LSHACs have better fitting abilities as well as more accurate out-of-sample Value-at-Risk estimates with less parameters. In addition, from a financial risk management point of view, the LSHACs have the advantage of being very flexible in modeling the asymmetric tail dependence, providing more conservative estimations of the probabilities of extreme downward co-movements in the financial market.

Suggested Citation

  • Zhu, Wenjun & Wang, Chou-Wen & Tan, Ken Seng, 2016. "Structure and estimation of Lévy subordinated hierarchical Archimedean copulas (LSHAC): Theory and empirical tests," Journal of Banking & Finance, Elsevier, vol. 69(C), pages 20-36.
  • Handle: RePEc:eee:jbfina:v:69:y:2016:i:c:p:20-36
    DOI: 10.1016/j.jbankfin.2016.01.011
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    More about this item

    Keywords

    High dimensional modeling; Hierarchical Archimedean copulas; Lévy subordinators; Downside risk;

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C16 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Econometric and Statistical Methods; Specific Distributions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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