Scandinavian Working Papers in Business Administration

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2006/10: Frequent Turbulence? A Dynamic Copula Approach

Lorán Chollete () and Andreas Heinen ()
Additional contact information
Lorán Chollete: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway
Andreas Heinen: Dept. of Statistics and Econometrics, Universidad Carlos III de Madrid, Postal: Universidad Carlos III de Madrid, Department of Statistics and Econometrics, Calle de Madrid 126, Getafe Madrid 28903, Spain

Abstract: How common and how persistent are turbulent periods? We address these questions by developing and applying a dynamic dependence framework. In order to answer the first question we estimate an unconditional mixture model of normal copulas, based on both economic and econometric justification. In order to answer the second question, we develop and estimate a hidden markov model of copulas, which allows for dynamic clustering of correlations. These models permit one to infer the relative importance of turbulent and quiescent periods in international markets. Empirically, the three most striking findings are as follows. First, for the unconditional model, turbulent regimes are more common. Second, the conditional copula model dominates the unconditional model. Third, turbulent regimes tend to be more persistent.

Keywords: International Markets; Turbulence; Hidden Markov Model; Copula

JEL-codes: C14; C22; C50; F30; G15

43 pages, October 11, 2006

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