The Most Entropic Canonical Copula with an Application To 'Style' Investment

57 Pages Posted: 4 Sep 2008

See all articles by Stephen E. Satchell

Stephen E. Satchell

University of Cambridge - Faculty of Economics and Politics

Ba M. Chu

Carleton University

Multiple version iconThere are 2 versions of this paper

Date Written: August, 25 2008

Abstract

We propose a new approach to recover relative entropy measures of dependence from limited information by constructing the most entropic copulas (MEC) and their canonical forms, namely, the most entropic canonical copulas (MECC). We show that our approach is in duality with the existing approaches such as the approach of minimum Kullback-Leibler cross entropy. Our empirical analysis focuses on an application of the MEC theory to a 'style investing' problem for an investor with constant relative risk aversion allocating wealth between the Russell 1000 'growth' and 'value' indices. We found that the gains from using the MECC in forming investment strategies are economically and statistically significant for the case with/without short-sales constraints.

Keywords: Entropy, Relative entropy measure of joint dependence, Copula, Most entropic

JEL Classification: C190, C590, C130

Suggested Citation

Satchell, Stephen E. and Chu, Ba M., The Most Entropic Canonical Copula with an Application To 'Style' Investment (August, 25 2008). Available at SSRN: https://ssrn.com/abstract=1256002 or http://dx.doi.org/10.2139/ssrn.1256002

Stephen E. Satchell

University of Cambridge - Faculty of Economics and Politics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom
44 (0)1223 335213 (Phone)
44 (0)1223 335475 (Fax)

HOME PAGE: http://www.econ.cam.ac.uk/faculty/satchell/index.h

Ba M. Chu (Contact Author)

Carleton University ( email )

Department of Economics
Ottawa, Ontario K1S 5B6
Canada

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