Closed-Form Multi-Factor Copula Models with Observation-Driven Dynamic Factor Loadings

Tinbergen Institute Discussion Paper 2019-013/IV

61 Pages Posted: 5 Nov 2019

See all articles by Anne Opschoor

Anne Opschoor

Vrije Universiteit Amsterdam

Andre Lucas

Vrije Universiteit Amsterdam - School of Business and Economics; Tinbergen Institute

Istvan Barra

VU University Amsterdam

Dick J. C. van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute; ERIM

Date Written: October 23, 2019

Abstract

We develop new multi-factor dynamic copula models with time-varying factor loadings and observation-driven dynamics. The new models are highly flexible, scalable to high dimensions, and ensure positivity of covariance and correlation matrices. A closed-form likelihood expression allows for straightforward parameter estimation and likelihood inference. We apply the new model to a large panel of 100 U.S. stocks over the period 2001–2014. The proposed multi-factor structure is much better than existing (single-factor) models at describing stock return dependence dynamics in high-dimensions. The new factor models also improve one-step-ahead copula density forecasts and global minimum variance portfolio performance. Finally, we investigate different mechanisms to allocate firms into groups and find that a simple industry classification outperforms alternatives based on observable risk factors, such as size, value or momentum.

Keywords: factor copulas, factor structure, score-driven dynamics, multivariate density forecast

JEL Classification: C32, C58, G17

Suggested Citation

Opschoor, Anne and Lucas, Andre and Barra, Istvan and van Dijk, Dick J.C., Closed-Form Multi-Factor Copula Models with Observation-Driven Dynamic Factor Loadings (October 23, 2019). Tinbergen Institute Discussion Paper 2019-013/IV. Available at SSRN: https://ssrn.com/abstract=3476239 or http://dx.doi.org/10.2139/ssrn.3476239

Anne Opschoor (Contact Author)

Vrije Universiteit Amsterdam ( email )

De Boelelaan 1105
Amsterdam, NL 1081 HV
Netherlands

Andre Lucas

Vrije Universiteit Amsterdam - School of Business and Economics ( email )

De Boelelaan 1105
Amsterdam, 1081 HV
Netherlands
+31 20 598 6039 (Phone)
+31 20 598 6020 (Fax)

HOME PAGE: http://personal.vu.nl/a.lucas

Tinbergen Institute

Roetersstraat 31
Amsterdam, 1018 WB
Netherlands

HOME PAGE: http://www.tinbergen.nl

Istvan Barra

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

Dick J.C. Van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute

P.O. Box 1738
3000 DR Rotterdam
Netherlands

ERIM ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 1263 (Phone)
+31 10 4089162 (Fax)

HOME PAGE: http://people.few.eur.nl/djvandijk

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