Modeling International Financial Returns with a Multivariate Regime-switching Copula

Loran Chollete, Andreas Heinen*, Alfonso Valdesogo

*Corresponding author for this work

    Research output: Contribution to journalArticlepeer-review

    194 Citations (Scopus)

    Abstract

    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 three 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, since it modifies the Value-at-Risk (VaR) of international portfolios and produces a better out-of-sample performance. Third, ignoring asymmetric dependence and regime-switching in portfolio selection leads to significant costs for an investor.

    Original languageEnglish
    Pages (from-to)437-480
    Number of pages44
    JournalJournal of Financial Econometrics
    Volume7
    Issue number4
    DOIs
    Publication statusPublished - 2009
    EventConference on Multivariate Volatility Models - Faro, Portugal
    Duration: 26 Oct 200727 Oct 2007

    Keywords

    • C32
    • C35
    • G10
    • asymmetric dependence
    • canonical vine copula
    • international returns
    • portfolio selection
    • regime-switching
    • risk management
    • Value at Risk
    • EQUITY MARKETS
    • TIME-SERIES
    • DEPENDENCE
    • RISK
    • RATES
    • STOCK

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