Forward-Looking Measures of Higher-Order Dependencies with an Application to Portfolio Selection

35 Pages Posted: 27 Jan 2014 Last revised: 19 May 2016

See all articles by Felix Brinkmann

Felix Brinkmann

University of Goettingen (Göttingen)

Alexander Kempf

University of Cologne - Department of Finance & Centre for Financial Research (CFR)

Olaf Korn

University of Goettingen (Göttingen)

Date Written: December 31, 2015

Abstract

This paper provides implied measures of higher-order dependencies between assets. The measures exploit only forward-looking information from the options market and can be used to construct an implied estimator of the covariance, co-skewness, and co-kurtosis matrices of asset returns. We show that higher-order dependencies vary heavily over time and identify the economic factors driving them. Furthermore, we run a portfolio selection exercise and show that investors can benefit from using the new estimator. They obtain a better risk-adjusted out-of-sample performance by up to 14% per year compared to when they use various historical and partially implied benchmark estimators.

Keywords: option-implied information, dependence measures, higher moments, portfolio selection

JEL Classification: G11, G13, G17

Suggested Citation

Brinkmann, Felix and Kempf, Alexander and Korn, Olaf, Forward-Looking Measures of Higher-Order Dependencies with an Application to Portfolio Selection (December 31, 2015). Available at SSRN: https://ssrn.com/abstract=2385228 or http://dx.doi.org/10.2139/ssrn.2385228

Felix Brinkmann

University of Goettingen (Göttingen) ( email )

Platz der Gottinger Sieben 3
Gottingen, D-37073
Germany

Alexander Kempf

University of Cologne - Department of Finance & Centre for Financial Research (CFR) ( email )

Cologne, 50923
Germany
+49 221 470 2714 (Phone)
+49 221 470 3992 (Fax)

Olaf Korn (Contact Author)

University of Goettingen (Göttingen) ( email )

Platz der Gottinger Sieben 3
Gottingen, D-37073
Germany
++49 551 39 7265 (Phone)
++49 551 39 7665 (Fax)

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