Canonical Vine Copulas in the Context of Modern Portfolio Management: Are They Worth It?

40 Pages Posted: 3 May 2013

See all articles by Rand Kwong Yew Low

Rand Kwong Yew Low

University of Queensland Business School

Jamie Alcock

The University of Sydney Business School; Centre for International Finance and Regulation (CIFR)

Robert W. Faff

University of Queensland

Timothy Brailsford

University of Queensland

Date Written: February 14, 2013

Abstract

In the context of managing downside correlations, we examine the use of multi-dimensional elliptical and asymmetric copula models to forecast returns for portfolios with 3 to 12 constituents. Our analysis assumes that investors have no short-sales constraints and a utility function characterized by the minimization of Conditional Value-at-Risk (CVaR). We examine the efficient frontiers produced by each model and focus on comparing two methods for incorporating scalable asymmetric dependence structures across asset returns using the Archimedean Clayton copula in an out-of-sample, long-run multi-period setting. For portfolios of higher dimensions, we find that modelling asymmetries within the marginals and the dependence structure with the Clayton canonical vine copula (CVC) consistently produces the highest-ranked outcomes across a range of statistical and economic metrics when compared to other models incorporating elliptical or symmetric dependence structures. Accordingly, we conclude that CVC copulas are ‘worth it’ when managing larger portfolios.

Keywords: vine copula, clayton copula, asymmetric dependence, portfolio management, canonical vine, Conditional Value-At-Risk

JEL Classification: G11, C16

Suggested Citation

Low, Rand Kwong Yew and Alcock, Jamie and Faff, Robert W. and Brailsford, Timothy, Canonical Vine Copulas in the Context of Modern Portfolio Management: Are They Worth It? (February 14, 2013). Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2259067

Rand Kwong Yew Low (Contact Author)

University of Queensland Business School ( email )

Building 37-411, Joyce Ackroyd
St Lucia
Brisbane, QLD 4122
Australia
+61 7 3346 8124 (Phone)
+61 7 3346 8166 (Fax)

HOME PAGE: http://www.business.uq.edu.au/staff/details/rand-low

Jamie Alcock

The University of Sydney Business School ( email )

Cnr. of Codrington and Rose Streets
Sydney, NSW 2006
Australia

Centre for International Finance and Regulation (CIFR) ( email )

Level 7, UNSW CBD Campus
1 O'Connell Street
Sydney, NSW 2000
Australia

Robert W. Faff

University of Queensland ( email )

St Lucia
Brisbane, Queensland 4072
Australia

Timothy Brailsford

University of Queensland ( email )

St Lucia
Brisbane, Queensland 4072
Australia

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