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Modeling international financial returns with a multivariate regime switching copula

  • CHOLLETE, Loran

    (Norwegian School of Economics and Business Administration (NHH))

  • HEINEN, Andréas

    (Universidad Carlos III de Madrid)

  • VALDESOGO, Alfonso

    (Université catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE))

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 Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2008013.

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Date of creation: 01 Mar 2008
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Handle: RePEc:cor:louvco:2008013
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