Scandinavian Working Papers in Business Administration

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

No 2008/3: Modeling International Financial Returns with a Multivariate Regime Switching Copula

Lorán Chollete (), Andréas Heinen () and Alfonso Valdesogo ()
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
Andréas Heinen: Dept. of Statistics and Econometrics, Universidad Carlos III de Madrid, Postal: Department of Statistics and Econometrics , University Carlos III , Calle de Madrid 126 , Getafe Madrid 28903, Spain
Alfonso Valdesogo: Center for Operations Research and Econometrics (CORE), Université Catholique de Louvain, Postal: Center for Operations Research and Econometrics, 34, Voie du Roman Pays, B-1348 Louvain-la-Neuve, Belgique

Abstract: In order to capture observed asymmetric dependence in international financial returns, we construct a multivariate regime-switching model of copulas. We model dependence with one Gaussian and one canonical vine copula regime. Canonical vines are constructed from bivariate conditional copulas and provide a very flexible way of characterizing dependence in multivariate settings. We apply the model to returns from the G5 and Latin American regions, and document two main findings. First, we discover that models with canonical vines generally dominate alternative dependence structures. Second, the choice of copula is important for risk management, because it modifies the Value at Risk (VaR) of international portfolio returns.

Keywords: Asymmetric dependence; Canonical vine copula; International returns; Regime-Switching; Risk Management; Value-at-Risk

JEL-codes: C32; C35; G10

43 pages, March 12, 2008

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