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Modeling International Financial Returns with a Multivariate Regime Switching Copula

  • Chollete, Lorán

    ()

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

  • Heinen, Andréas

    ()

    (Dept. of Statistics and Econometrics, Universidad Carlos III de Madrid)

  • Valdesogo, Alfonso

    ()

    (Center for Operations Research and Econometrics (CORE), Université Catholique de Louvain)

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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File URL: http://hdl.handle.net/11250/163946
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Paper provided by Department of Business and Management Science, Norwegian School of Economics in its series Discussion Papers with number 2008/3.

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Length: 43 pages
Date of creation: 12 Mar 2008
Date of revision:
Handle: RePEc:hhs:nhhfms:2008_003
Contact details of provider: Postal: NHH, Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway
Phone: +47 55 95 92 93
Fax: +47 55 95 96 50
Web page: http://www.nhh.no/en/research-faculty/department-of-business-and-management-science.aspx
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  18. Rodriguez, Juan Carlos, 2007. "Measuring financial contagion: A Copula approach," Journal of Empirical Finance, Elsevier, vol. 14(3), pages 401-423, June.
  19. 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 339-50, July.
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  23. 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.
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