Modeling Dependence Structure and Forecasting Market Risk with Dynamic Asymmetric Copula

51 Pages Posted: 30 Jun 2014 Last revised: 20 Jun 2015

See all articles by Mario Cerrato

Mario Cerrato

London Metropolitan University - Department of Economics, Finance and International Business (EFIB)

John Crosby

University of Maryland - Robert H. Smith School of Business

Minjoo Kim

University of Liverpool - Accounting and Finance Division

Yang Zhao

Central University of Finance and Economics (CUFE) - Chinese Academy of Finance and Development

Date Written: February 24, 2015

Abstract

We investigate the dynamic and asymmetric dependence structure between equity portfolios from the US and UK. We demonstrate the statistical significance of dynamic asymmetric copula models in modelling and forecasting market risk. First, we construct "high-minus-low" equity portfolios sorted on beta, coskewness, and cokurtosis. We find substantial evidence of dynamic and asymmetric dependence between characteristic-sorted portfolios. Second, we consider a dynamic asymmetric copula model by combining the generalized hyperbolic skewed t copula with the generalized autoregressive score (GAS) model to capture both the multivariate non-normality and the dynamic and asymmetric dependence between equity portfolios. We demonstrate its usefulness by evaluating the forecasting performance of Value-at-Risk and Expected Shortfall for the high-minus-low portfolios. From backtesting, we find consistent and robust evidence that our dynamic asymmetric copula model provides the most accurate forecasts, indicating the importance of incorporating the dynamic and asymmetric dependence structure in risk management.

Keywords: Asymmetry; Tail dependence; Dependence dynamics; Dynamic skewed t copulas; VaR and ES forecasting

JEL Classification: C32, C53, G17, G32

Suggested Citation

Cerrato, Mario and Crosby, John and Kim, Minjoo and Zhao, Yang, Modeling Dependence Structure and Forecasting Market Risk with Dynamic Asymmetric Copula (February 24, 2015). Available at SSRN: https://ssrn.com/abstract=2460168

Mario Cerrato

London Metropolitan University - Department of Economics, Finance and International Business (EFIB) ( email )

Economics Subject Group, LMBS
London EC2M 6SQ, EC2M 6SQ
United Kingdom

John Crosby

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
+447979901892 (Phone)

HOME PAGE: http://www.john-crosby.co.uk/

Minjoo Kim

University of Liverpool - Accounting and Finance Division ( email )

227 Grove
Management School
Liverpool, Liverpool L69 3BX
United Kingdom

HOME PAGE: http://https://www.liverpool.ac.uk/management/staff/minjoo-kim/

Yang Zhao (Contact Author)

Central University of Finance and Economics (CUFE) - Chinese Academy of Finance and Development ( email )

39 South College Road
Beijing
China

Register to save articles to
your library

Register

Paper statistics

Downloads
241
Abstract Views
1,199
rank
128,833
PlumX Metrics