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A Dynamic Grouped-T Copula Approach For High-Dimensional Portfolios
A Dynamic Grouped-T Copula Approach For High-Dimensional Portfolios
A Dynamic Grouped-T Copula Approach For High-Dimensional Portfolios
Dean Fantazzini
1st Introduction
1st Introduction
1st Introduction
1st Introduction
1st Introduction
1st Introduction
6th Conclusions
The increasing complexity of financial markets has pointed out the need
for advanced dependence modelling in finance. Why?
Daul, Giorgi, Lindskog, and McNeil (2003), Demarta and McNeil (2005)
and Mc-Neil, Frey, and Embrechts (2005) underlined the ability of the
grouped t-copula to model the dependence present in a large set of
financial assets into account.
p
Let Gν denote the distribution function of ν/χν , where χν is a chi
square distribution with ν degrees of freedom, and partition 1, . . . , n into
m subsets of sizes s1 , . . . , sm . Set Wk = G−1 νk (U ) for k = 1, . . . , m and then
Y|Ft−1 = (W1 Z1 , . . . , W1 Zs1 , W2 Zs1 +1 , . . . , W2 Zs1 +s2 , . . . , Wm Zn ), so
that Y has a so-called grouped t distribution. Finally, define
U|Ft−1 = (tν1 (Y1 ), . . . , tν1 (Ys1 ), tν2 (Ys1 +1 ), . . . , tν2 (Ys1 +s2 ), . . . , tνm (Yn ))
(1)
Note that (Y1 , . . . , Ys1 ) has a t distribution with ν1 degrees of freedom, and
in general for k = 1, . . . , m − 1, (Ys1 +...+sk +1 , . . . , Ys1 +...+sk+1 ) has a t
distribution with νk+1 degrees of freedom. Similarly, subvectors of U have
a t-copula with νk+1 degrees of freedom, for k = 0, . . . , m − 1.
where i and j belong to different groups and τij is the pairwise Kendall’s
tau. This approximation then allows for Maximum Likelihood estimation
for each subgroup separately.
τ τ
ˆ ˆ
in an empirical Kendall’s tau matrix Σ̄ defined by Σ̄jk = τ̄ˆ(ûj , ûk ),
and then construct the unconditional correlation matrix using this
τ
ˆ π ˆ
relationship R̄j,k = sin( 2 Σ̄j,k ), where the estimated parameters are the
q = n · (n − 1)/2 unconditional correlations [ρ̄1 , . . . , ρ̄q ]′ .
k = 1, . . . , m − 1 (5)
E [ψ (Fi (ηi ), Fj (ηj ); ρ̄i,j )] = E [ρ̄(zi , zj ) − sin(πτ (Fi (ηi ), Fj (ηj ))/2)] = 0 (9)
E [ψ1 (F1 (η1 ), F2 (η2 ); ρ̄1 )]
..
ψ (F1 (η1 ), . . . , Fn (ηn ); θ0 ) = =0
.
E [ψq (Fn−1 (ηn−1 ), Fn (ηn ); ρ̄q )]
(10)
(ii) the q-variate moment vector ψ (F1 (η1 ), . . . , Fn (ηn ); θ0 ) defined in (10)
is continuous in θ0 for all ηi ,
Ψ F1 (η1,t ), . . . , Fn (ηn,t ); Ξ̂ =
T
1
ψ1 F1 (η1,t ), F2 (η2,t ); ρ̄ˆ1
P
T
t=1
..
.
T
1
ˆ
P
T
ψq Fn−1 (ηn−1,t ), Fn (ηn,t ); ρ̄q
t=1
T
ˆ
1 P
T
ψν1 F1 (η1,t ), . . . , Fs1 (ηs1,t ); R̄, ν̂1
t=1
= =0
..
.
T
1 P ˆ
ψνm Fs1 +...+sm−1 +1 (ηs1 +...+sm−1 +1,t ), . . . , Fn (ηn,t ); R̄, ν̂m
T
t=1
T
1 P ˆ
ψα (F1 (η1,t ), . . . , Fn (ηn,t ); R̄, α̂, β̂)
T
t=1
T
ˆ
1 P
T
ψβ (F1 (η1,t ), . . . , Fn (ηn,t ); R̄, α̂, β̂)
t=1
Let also define the population moments vector with a correction to take
the non-parametric estimation of the marginals into account, together with
its variance (see Genest et al. (1995), § 4):
ψ1 (F1 (η1 ), F2 (η2 ); ρ̄1 )
.
..
ψq (Fn−1 (ηn−1 ), Fn (ηn ); ρ̄q )
s
P 1
ψν1 F1 (η1 ), . . . , Fs1 (ηs1 ); R̄, ν1 + Wi,ν1 (ηi )
i=1
..
∆0 =
.
Pn
ψνm Fs1 +...+sm−1 +1 (η1 ), . . . , Fn (ηn ); R̄, νm + Wi,νm (ηi )
i=s1 +...+sm−1 +1
n
P
ψα (F1 (η1 ), . . . , Fn (ηn ); R̄, α, β) + Wi,α (ηi )
i=1
n
P
ψβ (F1 (η1 ), . . . , Fn (ηn ); R̄, α, β) + Wi,β (ηi )
i=1
(11)
′
Υ0 ≡ var [∆0 ] = E ∆0 ∆0 (12)
where
∂2
Z
Wi,ν1 (ηi ) = 1l Fi (ηi )≤ui log c(u1 , . . . us1 ; R̄, ν1 )dC(u1 , . . . , us1 )
∂ν1 ∂ui
..
. (13)
∂2
Z
Wi,νm (ηi ) = 1l Fi (ηi )≤ui log c(ui=s1 +...+sm−1 +1 , . . . un ; R̄, νm )
∂νm ∂ui
dC(ui=s1 +...+sm−1 +1 , . . . , un )
(14)
∂2
Z
Wi,α (ηi ) = 1l Fi (ηi )≤ui log c(u1 , . . . un ; R̄, α, β)dC(u1 , . . . , un )
∂α∂ui
∂2
Z
Wi,β (ηi ) = 1l Fi (ηi )≤ui log c(u1 , . . . un ; R̄, α, β)dC(u1 , . . . , un )
∂β∂ui
(15)
The previous asymptotic properties hold only under the very special case
when zi , zj are uncorrelated and R is the identity matrix. When this
restriction does not hold, the estimation procedure previously described
may not deliver consistent estimates.
They showed that the correlations parameters present a bias that increases
nonlinearly in Rj,k , but the magnitude of the error is rather low. Instead,
no evidence is reported for the degrees of freedom.
Particularly, when there is high tail dependence (νk are low) the
convergence is much quicker than when there is low tail dependence
(νk are high). Furthermore, the convergence is quicker when there is
strong persistence in the correlations structure (β is high), rather than
the persistence is weak (β is low).
This is good news since financial assets usually show high tail
dependence and high persistence in the correlations (see Mcneil et al.
(2005) and references therein). Besides, it is interesting to note that
the biases are negative for all the considered DGPs, i.e. the estimated
ν̂k are lower than the true values νk .
• the error in the approximation of the quantiles is lower the lower the
tail dependence between assets is, i.e. when νk are high, ceteris
paribus. As a consequence, when estimating the quantile they tend to
offset the effect of lower correlations, which would decrease the
computed quantile, instead.
• the approximations of the extreme quantiles are much better than those
of the central quantiles, while the analysis reveals no major difference
between left tail and right tail.
where et+1 = Lt+1 − V aR\ t+1|t , Lt+1 is the realized loss, while
\
V aR t+1|t is the VaR forecast at time t + 1 on information available at
time t.
4. Hansen’s (2005) Superior Predictive Ability (SPA) test: The
SPA test is a test that can be used for comparing the performances of
two or more forecasting models.
The forecasts are evaluated using a prespecified loss function and the
“best” forecast model is the model that produces the smallest loss.
Long positions
0.25% 0.50% 1% 5%
M. N/T pU C pCC N/T pU C pCC N/T pU C pCC N/T pU C pCC
1) 1.40% 0.00 0.00 1.90% 0.00 0.00 2.30% 0.00 0.00 6.30% 0.07 0.19
2) 1.30% 0.00 0.00 1.60% 0.00 0.00 1.90% 0.01 0.03 5.80% 0.26 0.49
3) 0.90% 0.00 0.01 1.40% 0.00 0.00 2.00% 0.01 0.01 6.60% 0.03 0.08
4) 0.60% 0.06 0.17 1.40% 0.00 0.00 1.90% 0.01 0.03 6.20% 0.09 0.24
5) 0.80% 0.01 0.02 1.30% 0.00 0.00 1.90% 0.01 0.03 6.10% 0.12 0.18
6) 0.50% 0.16 0.37 1.10% 0.02 0.02 1.80% 0.02 0.05 6.00% 0.16 0.35
Short positions
0.25% 0.50% 1% 5%
M. N/T pU C pCC N/T pU C pCC N/T pU C pCC N/T pU C pCC
1) 0.80% 0.01 0.02 1.00% 0.05 0.06 1.50% 0.14 0.16 5.30% 0.67 0.71
2) 0.70% 0.02 0.06 0.90% 0.11 0.06 1.30% 0.36 0.56 5.00% 1.00 0.95
3) 0.20% 0.74 0.94 0.70% 0.40 0.07 0.90% 0.75 0.87 5.90% 0.20 0.43
4) 0.30% 0.76 0.95 0.70% 0.40 0.06 0.90% 0.75 0.87 5.50% 0.47 0.77
5) 0.30% 0.76 0.95 0.80% 0.22 0.06 0.90% 0.75 0.87 4.80% 0.77 0.54
6) 0.30% 0.76 0.95 0.70% 0.40 0.35 0.90% 0.75 0.87 5.20% 0.77 0.94
References
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Framework for the Use of Backtesting in Conjunction with the Internal
Models Approach to Market Risk Capital Requirements, Basel, January.
[2] Basle Committee on Banking Supervision (2005). Amendment to the
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[6] Demarta, S. and McNeil, A. J. (2005). The t Copula and Related
Copulas, International Statistical Review, 73, 111 –129.
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[8] Fantazzini, D. (2009a). A Dynamic Grouped-T Copula Approach for