Higher Order Comoments and Dependence Structure of Equity Portfolio

Abstract

We study a relation between higher order comoments and dependence structure of equity portfolio in the US and UK by relying on a simple portfolio approach where equity portfolios are sorted on the higher order comoments. We find that beta and coskewness are positively related with a copula correlation, whereas cokurtosis is negatively related with it. We also find that beta positively associates with an asymmetric tail dependence whilst coskewness negatively associates with it. Furthermore, two extreme equity portfolios sorted on the higher order comments are closely correlated and their dependence structure is strongly time-varying and nonlinear. Backtesting results of value-at-risk and expected shortfall demonstrate the importance of modeling a dynamic and asymmetric dependence in the risk management.

Keywords: Higher Order Comoments, Dependence Structure, Hyperbolic Generalized Skewed t Copula, Generalized Autoregressive Score, Risk Management

JEL Classification: C53, G17