Financial dependence analysis: applications of vine copulas

David E. Allen, Mohammad A. Ashr, Michael Mcaleer, Robert J. Powell, Abhay K. Singh

Research output: Contribution to journalArticleResearchpeer-review

Abstract

This paper features the application of a novel and recently developed method of statistical and mathematical analysis to the assessment of financial risk, namely regular vine copulas. Dependence modelling using copulas is a popular tool in financial applications but is usually applied to pairs of securities. Vine copulas offer greater flexibility and permit the modelling of complex dependence patterns using the rich variety of bivariate copulas that can be arranged and analysed in a tree structure to facilitate the analysis of multiple dependencies. We apply regular vine copula analysis to a sample of stocks comprising the Dow Jones index to assess their interdependencies and to assess how their correlations change in different economic circumstances using three different sample periods around Global Financial Crisis (GFC).: pre-GFC (January 2005 to July 2007), GFC (July 2007 to September 2009) and post-GFC periods (September 2009 to December 2011). The empirical results suggest that the dependencies change in a complex manner, and there is evidence of greater reliance on the Student-t copula in the copula choice within the tree structures for the GFC period, which is consistent with the existence of larger tails in the distributions of returns for this period. One of the attractions of this approach to risk modelling is the flexibility in the choice of distributions used to model co-dependencies. The practical application of regular vine metrics is demonstrated via an example of the calculation of the Value at Risk of a portfolio of stocks.

LanguageEnglish
Pages403-435
Number of pages33
JournalStatistica Neerlandica
Volume67
Issue number4
DOIs
Publication statusPublished - Nov 2013
Externally publishedYes

Fingerprint

Copula
Financial Crisis
Tree Structure
Flexibility
Modeling
Financial Risk
Value at Risk
Interdependencies
Mathematical Analysis
Statistical Analysis
Tail
Global financial crisis
Economics
Metric

Keywords

  • Co-dependence modelling
  • Regular vine copulas
  • Tree structures

Cite this

Allen, David E. ; Ashr, Mohammad A. ; Mcaleer, Michael ; Powell, Robert J. ; Singh, Abhay K. / Financial dependence analysis : applications of vine copulas. In: Statistica Neerlandica. 2013 ; Vol. 67, No. 4. pp. 403-435.
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Financial dependence analysis : applications of vine copulas. / Allen, David E.; Ashr, Mohammad A.; Mcaleer, Michael; Powell, Robert J.; Singh, Abhay K.

In: Statistica Neerlandica, Vol. 67, No. 4, 11.2013, p. 403-435.

Research output: Contribution to journalArticleResearchpeer-review

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