Risk measurement and risk modelling using applications of Vine copulas

David E. Allen*, Michael McAleer, Abhay K. Singh

*Corresponding author for this work

Research output: Contribution to journalArticle

10 Citations (Scopus)
15 Downloads (Pure)

Abstract

This paper features an application of Regular Vine copulas which are a novel and recently developed statistical and mathematical tool which can be applied in the assessment of composite financial risk. Copula-based dependence modelling is a popular tool in financial applications, but is usually applied to pairs of securities. By contrast, Vine copulas provide greater flexibility and permit the modelling of complex dependency patterns using the rich variety of bivariate copulas which may be arranged and analysed in a tree structure to explore multiple dependencies. The paper features the use of Regular Vine copulas in an analysis of the co-dependencies of 10 major European Stock Markets, as represented by individual market indices and the composite STOXX 50 index. The sample runs from 2005 to the end of 2013 to permit an exploration of how correlations change indifferent economic circumstances using three different sample periods: pre-GFC (January 2005-July 2007), GFC (July 2007- September 2009), and post-GFC periods (September 2009-December 2013). The empirical results suggest that the dependencies change in a complex manner, and are subject to change in different economic circumstances. 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 VaR of a portfolio made up of the indices.

Original languageEnglish
Article number1762
Number of pages34
JournalSustainability (Switzerland)
Volume9
Issue number10
DOIs
Publication statusPublished - 29 Sep 2017
Externally publishedYes

Bibliographical note

Copyright the Author(s) 2017. Version archived for private and non-commercial use with the permission of the author/s and according to publisher conditions. For further rights please contact the publisher.

Keywords

  • co-dependence modelling
  • European stock markets
  • regular vine copulas
  • tree structures

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