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Selecting pair-copulas with downside risk minimisation

Author

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  • Jin Zhang
  • Dietmar Maringer

Abstract

Copulas provide investors with tools to model the dependence structure of financial products. The choice of copulas plays an important role in successful copula applications. This paper discusses the copula selection problem for the so-called 'D-vine' decomposition from a perspective of the 'safety first' asset allocation. The Joe-Clayton copula and the Student t copula are considered as building blocks for the D-vine structure. As an alternative to conventional approaches, the proposed pair-copula-GARCH model provides simulated asset returns for the optimal asset allocation which is implemented by using a heuristic optimisation approach. When assessing the reliability of portfolio loss prediction, it is found that the EWMA of RiskMetrics performs slightly better than the copula-GARCH models in the study of value-at-risk and expected shortfall minimisation. However, the Joe-Clayton copula model outperforms the EWMA in the case of Omega ratio minimisation.

Suggested Citation

  • Jin Zhang & Dietmar Maringer, 2011. "Selecting pair-copulas with downside risk minimisation," International Journal of Financial Markets and Derivatives, Inderscience Enterprises Ltd, vol. 2(1/2), pages 121-148.
    • Handle: RePEc:ids:ijfmkd:v:2:y:2011:i:1/2:p:121-148
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    Cited by:

    1. Travkin, Alexandr, 2013. "Pair copula constructions in portfolio optimization ploblem," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 32(4), pages 110-133.

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