05 WBL-SAoFD Lecture5

ETH Zürich, WBL Angewandte Statistik 2017
Blockkurs
Statistical Analysis
of Financial Data
Prof. Dr. Andreas Ruckstuhl

Dozent für Statistische Datenanalyse
Institut für Datenanalyse und Prozess Design IDP
Zürcher Hochschule für Angewandte Wissenschaften ZHAW
andreas.ruckstuhl@zhaw.ch
30. Januar 2017
A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 1

Outline of Lecture 5
• Lecture 1: Financial Data and Their Properties

• Lecture 2: Model for Conditional Heteroskedasticity and Risk Measures
• Lecture 3: Statistical Issues When Applying Portfolio Theory
• Lecture 4: (Financial) Factor Models
• Lecture 5: Copulas
– Basic Theory
– Gaussian and t-Copulas
– Archimedean Copulas
– Rank Correlation
– Tail Dependence
– Calibrating Copulas (i.e., Estimating Copulas)
– *Vine Copula
8.1 Introduction
The statistical analysis of multivariate Date is classically based on the

multivariate normal distribution.
• As a consequence we need just to bother estimating

– the mean/expectation and
– the covariance matrix
from the data.
• The stochastic dependence between two normally distributed variables is

described by the covariance
The covariance between two random variables depends on their variances as well
as the strength of the linear relationship between them (see also slide 6, Part 3)
• To understand the relationship between variables, it is much better to

examine their (sample) correlation matrix.

Example: Daily returns on two equities GE and IBM and
on CRSP, a value-weighted index including dividends
(Jan 3,1969 to Dec 31, 1998)
> round(cov(Stocks),6) > round(cor(Stocks),3)
ge ibm CRSP ge ibm CRSP
ge 0.000188 0.000080 7.6e-05 ge 1.000 0.334 0.715
ibm 0.000080 0.000306 6.6e-05 ibm 0.334 1.000 0.486
CRSP 0.000076 0.000066 6.0e-05 CRSP 0.715 0.486 1.000
Most people use the correlation matrix for examination:

– All sample correlations are positive
– The largest correlation is between CRSP and ge
–…
• The correlation coefficients is only a summary of the linear relationship between

variables.
• Interesting features, such as nonlinearity or the joint behaviour of extreme

values, remain hidden
A way out of this shortcomings is the so-called scatterplot matrix:
• One sees little evidence of nonlinear relationships, but some structures

caused by “non-normal” (i.e., non-Gaussian) events.
• This lack of nonlinearities is typical of returns on equities, but it should not be

taken for granted – instead, one should always look at the scatterplot matrix.

8.2 Basic Theory
Modelling multivariate distributions beyond normal distributions need an

new approach to model dependencies (instead of correlations)
A copula is a multivariate cumulative distribution function (CDF) whose

univariate marginal distributions are all uniform [0,1]
Remember: If Y has a continuous CDF F, then F(Y) has a Uniform(0,1)

distribution
T
• Suppose Y =(Y1, …, Yd) has a multivariate CDF
with continuous marginal univariate CDF
– Then the CDF of is a copula.
This CDF is called the copula of Y and denoted by CY
that is
– CY contains all information about dependencies among the

components of Y …
… but has no information about the marginal CDFs of Y.
• Sklar’s Theorem “justifies” the copula approach.
It states that the joint CDF FY can be decomposed into
– the copula CY , which contains all information about the dependencies among
(Y1, . . . , Yd), and
– the univariate marginal CDFs , which contain all information
about the univariate marginal distributions.
• That is
Motivation:
• For calibration we need an expression in terms of the joint density:
• The independence copula:

Example:
Scatterplot of the three daily return series (GE, IBM and CRSP) (cf. slide 5)
transformed to uniform marginals

8.3 Gaussian and t-Copulas
Using copulas to model multivariate dependencies,

we need parametric families of copulas.
→ The dependencies within Y is described by the correlation matrix Ω of Y

since the copula does not depend on the univariate marginal distribution (including variance)
→ Hence, the copula CY depends only on the correlation matrix Ω of Y
• The Gaussian copula with correlation matrix Ω will be denoted

• A distribution with a Gaussian copula is called a meta-Gaussian distribution.
This does not mean that Y has a multivariate Gaussian distribution, since the univariate
distributions could be any distribution at all.
• Example: Meta-Gaussian distribution for 2 dimensions:

Transform the marginal distribution to uniformity and apply a standard two-
dimensional Gaussian distribution with correlation ρ on it
where Φ-1() is the inverse of the standard Gaussian distribution and

Φ2(·,·, ρ) the bivariate distribution of two standard Gaussian distribution with correlation ρ
Example in R: Gaussian copula for 2 dim – different marginals
• library(copula)
nC1 <- normalCopula(0.8, dim=2) # define the copula model
set.seed(5640)
rnC1 <- rCopula(1000, nC1) # generate 1000 random numbers
• Margins: Gamma and beta distributed

x <- qgamma(rnC1[,1],2)
y <- qbeta(rnC1[,2],1,2)
plot(x,y) # they correlate!

Meta-Gaussian distribution became enormously popular ...
... in the end causing problems because the market too strongly believed in it
(→ 2007 subprime crises)
→ “The Gauss-copula is the worst invention ever for credit risk management”.
(A risk Probabilist)
see also http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all
t-copula
Similarly, let be the copula of a multivariate t-distribution with

correlation matrix Ω and degrees of freedom ν (The same for all dimensions).
The shape parameter ν affects both the univariate marginal distribution and
the copula, so ν is a parameter of the copula.
A distribution with a t-copula is called a t-meta distribution.

distribution

> library(copula)
> tC1.3 <- tCopula(c(-.6,0.75,0), dim=3, > tC25.3 <- tCopula(c(-0.6,0.75,0),
dispstr="un", df=1) dim=3, df=25)
> set.seed(5640) > set.seed(5640)
> r.tC1.3 <- rCopula(500, tC1.3) > r.tC25.3 <- rCopula(500 , tC25.3)
> pairs(r.tC1.3) > pairs(r.tC25.3)
> cor(r.tC1.3) > cor(r.tC25.3)
[,1] [,2] [,3]
[,1] [,2] [,3] [1,] 1.0000000 -0.5702485 0.7576589
[1,] 1.0000000 -0.49562992 0.72293656 [2,] -0.5702485 1.0000000 -0.0279640
[2,] -0.4956299 1.00000000 -0.04395247 [3,] 0.7576589 -0.0279640 1.0000000
[3,] 0.7229366 -0.04395247 1.00000000

8.4 Archimedean Copulas
An Archimedean copula wit a strict generator has the form
, (†)
where g() is the generator of the copula and satisfies
1. g is continuous, strictly decreasing, convex mapping [0,1] onto [0,∞)
2. g(0)= ∞ and g(1)=0
Notice that in (†), the value of C(u1, …, ud) is unchanged

if we permute u 1, …, ud .
One consequence of this property (called exchangeability) is:

rank correlations (see later) are the same for all pairs of variables.
 Archimedian copulas are most useful in the bivariate case or

in applications where we expect all pairs to have similar dependencies

Three generators for Archimedean copulas:
• Frank copula
Generator:
Inverse Generator:
→ bivariate Frank copula:

using (†)
– “θ=0” requires some care. Evaluate the limit of , which yields the
(bivariate) independence copula C0:
• Clayton copula
Generator
→ Clayton copula
The Clayton copula for θ=0 is defined as the independence copula C0.
For -1 < θ < 0 the copula is not strict and there is no probability,
e.g. for d=2: if u1 and u2 are both small then occurs.
In theses cases, the Clayton copula is set equal to 0.
• Gumbel copula
Generator:
Gumbel copula:
The Gumbel copula is the independent copula when θ=1

but it cannot have negative dependence.
• Simulations
On the next slides, simulation of bivariate samples are shown using scatterplots
– All simulations are with a sample size of 200
– And with values of that give dependencies ranging from strongly negative (if
possible) to strongly positive

• Random samples
from Frank copulas

• Random samples
from Clayton copulas

• Random samples
from Gumbel copulas

• Some remarks to the simulation results:
– the Frank and Clayton copulas are rather different
when the amount of dependence is somewhere between the extremes.
• In particular, the Clayton copula's exclusion of the region
when -1 < θ < 0 is evident, especially in the example with θ=-07
• The Frank copula is symmetric about the diagonal from (0, 1) to (1, 0),
but the Clayton copula does not have this symmetry.
– It is clearly seen that the Gumbel copula cannot model negative
dependencies.

8.5 Tail Dependence
• Tail dependence measures association between the extreme values of

two random variables and depends only on their copula.
Suppose that Y=(Y1, Y2)T is a bivariate random vector with copula CY.
Lower Tail Dependence

• The coefficient of lower tail dependence is denoted by l and defined as
P Y2 £ FY-2 1 (q ) and Y1 £ FY-11 (q )

ll := lim P Y2 £ FY-2 1 (q) | Y1 £ FY-11 (q) = lim
q ¯0 q ¯0 P Y1 £ FY-11 (q )
P FY2 (Y2 ) £ q and FY1 (Y1 ) £ q CY (q, q )
= lim = lim
q ¯0 P FY1 (Y1 ) £ q q ¯0 q
• If Y1 and Y2 are independent, then

Therefore, l = 0 implies that in the extreme left tail, Y1 and Y2 behave as
they are independent.

• Upper Tail Dependence
The coefficient of upper tail dependence is defined analogously
• For Gaussian and t-Copula,
• Knowing whether or not there is tail dependence is important for risk

management.
– If there are no tail dependencies among the returns on the assets in a
portfolio, then there is little risk of clusters of very negative returns, and the
risk of an extreme negative return on the portfolio is low.
– Conversely, if there are tail dependencies, then the likelihood of extreme
negative returns occurring simultaneously on several assets in the portfolio
can be high.

Tail Dependence for Gaussian and t-Copulas
• Gaussian Copula: λl= 0, if correlation is ρ≠1. That is,
Gaussian copulas do not have tail dependence except in case of ρ=1
• T-Copula with correlation ρ:
where Ft,ν+1 is the CDF of the t-distribution with (υ+1) degree of freedom.
– Since Ft,ν+1(-∞) = 0, we see

that λl → 0 if υ→ ∞
(i.e., consistent with Gaussian
Copula)
– Left: Coefficients of
tail-dependence for some
t-copulas

• Tail Dependance of Archimedean copulas
In case of d=2, it can be shown that
– The Gumbel copula is able to model upper tail dependency, but no
lower, whereas
– The Calyton copula can model lower tail dependence, but no upper:
– The Frank copula is not able to model either tail dependencies.
• Financial markets: losses occur more often jointly than gains do

8.6 Calibrating Copulas (i.e., Estimating Copulas)
Assume that we have an i.i.d. sample

and we wish to estimate the joint distribution using a copula approach.
• An important task is choosing a copula model.

An appropriate copula model can be selected using graphical techniques as well as
with AIC (see below) after fitting
• The fitting of the selected model is based on the log-likelihood of (cf. Slide 7)
• A direct maximum likelihood estimation may be too challenging because

– the large number of parameter cause numerical problems
– if any of the marginals are not well fitted by a convenient parametric family, this
may cause bias in the estimated parameters of both the marginals and the
copula
• A pseudo-maximum likelihood estimation may be more convenient.

It is a two-step process, where each part (red, green) is estimated
separately
• In a first step, each of the d marginal distribution functions are estimated,
one at a time (green part): →
There are two approaches, parametrically and nonparametrically.
– Parametrically: Fit convenient parametric distribution functions to each of the
marginal distributions using maximum likelihood estimators
– Nonparametrically: The marginal distribution is estimated by the empirical
CDF:
[The divisor (n+1) ensures that the maximum value of is (n/(n+1) < 1]
• In a second step,
is maximised over the parameter of the copula

– Also the maximisation of this step can be difficult when is high-
dimensional .
E.g., if one uses a t-Copula, then there are d(d-1) correlation parameters
→ good starting values are needed (see next slide)
8.6.1 Estimation of  in the Meta-t-Distribution
• The Pearson correlation coefficient ρ measures the linear dependency

between two random variables. A such it is not convenient for the
copulas approach because
– It is not invariant under nonlinear strictly increasing transformations
– Hence, it depends on the univariate marginal distributions as well as the
copula.
– Marginal distribution and correlation do not determine the joint distribution
except in case of Gaussian marginals
• Rank correlation coefficients remedy this problem, since they depend

only on the copula
• Spearman’s rank correlation

depends only on the copula because it is invariant to any monotonically increasing
transformation of the random variables; hence under CDF transformation as well.
It is calculated as Pearson correlation of the ranks of the variables and estimates

the Pearson correlation of the CDF transformed variables:

Another version which is based on ranks is Kendall’s tau
• Let are two copies of independent bivariate of

random variables. Then are called a concordant pair
if either .
In either case,
Similarly, are called a disconcordant pair

if
• Kendall's tau is the probability of a concordant pair minus the probability

of a discordant pair. Therefore, Kendall’s tau for is
The sample Kendall’s tau of a bivariate sample

is

• Kendall’s tau has the following relation to Ω:
• Hence we can use as estimate (or starting value)
• Unfortunately, this matrix may not be positive (semi-) definite.

must be adjusted
– Determine the eigenvalues "λ" and eigenvectors of
– Calculate
where E is the matrix of the eigenvectors and ε a small number > 0,
e.g., ε =0.001
– But now the diagonal elements of may not be equal to 1
– Hence, a easy fix yields the final solution:
multiply the ith row and the ith column of
The final result is called

8.6.2 Example: Bivariate data set of returns on IBM and the CRSP index
library(Ecdat)
data(CRSPday, package="Ecdat")
IBM <- as.numeric(CRSPday[,5])
CRSP <- as.numeric(CRSPday[,7])
## Fitting marginal t-distributions using package QRM

> library(QRM)
> IBM.tfit <- fit.st(IBM) ## fit a "scale-location" t-distribution
> (IBM.est <- IBM.tfit$par.ests)
nu mu sigma
4.1533842239 0.0002873347 0.0125834588
> CRSP.tfit <- fit.st(CRSP)
>(CRSP.est <- CRSP.tfit$par.ests)
nu mu sigma
3.4706229974 0.0009034934 0.0052143529
## Transformation of the data to uniform margins
pstd <- function (q, mean=0, sigma=1, nu = 5) { # X  U
## sd=sigma*s with s=sqrt(nu/(nu - 2))
z <- (q – mean)/sigma ## i.e., sd(z) = sqrt(nu/(nu - 2))
pt(q = z, df = nu)
}
UD <- cbind(pstd(IBM, IBM.est["mu"], IBM.est["sigma"], IBM.est["nu"]),

pstd(CRSP, CRSP.est["mu"], CRSP.est["sigma"], CRSP.est["nu"]))
## Are the marginal distribution uniformly distributed?
> h.n1 <- length(IBM)/10
> h.t <- h.n1 + 2*c(1,-1)*sqrt(h.n1) ## "confidence band" for height
## of bars in histogram
> hist(IBM, col=gray(0.9))
> hist(CRSP, col=gray(0.9))
> hist(UD[,1], col=gray(0.9))
> abline(h=h.t, col="gray")
> hist(UD[,2], col=gray(0.9))
> abline(h=h.t, col="gray")

## Fitting t copula in several steps
## from Kendall’s tau to an estimation of Omega
> (rhoTau <- cor(IBM, CRSP, method="kendall"))
[1] 0.3308049
> (omega <- sin(pi/2*rhoTau))
[1] 0.4965565
## Define the t-copula using Omega as correlation parameter

> require(copula)
> tc2 <-tCopula(omega, dim=2)
## fit by "maximum pseudo-likelihood"

> (UD.tc2 <- fitCopula(tc2, data=UD, method="mpl",start=c(omega,8),
+ optim.method="L-BFGS-B", lower=c(0.1, 5.5), upper=c(0.7, 15)))
fitCopula() estimation based on 'maximum pseudo-likelihood'
and a sample of size 2528.
Estimate Std. Error z value Pr(>|z|)
rho.1 0.49324 0.02458 20.07 <2e-16 ***
df 9.80896 NA NA NA
---
The maximized loglikelihood is 362.2
Optimization converged

## Fitting Gumbel, Frank and Clayton copulas
> (UD.gc2 <- fitCopula(copula=gumbelCopula(3,dim=2), data=UD,
+ method="mpl", optim.method="BFGS"))
fitCopula() estimation based on 'maximum pseudo-likelihood'
and a sample of size 2528.
Estimate Std. Error z value Pr(>|z|)
param 1.43005 0.02205 64.85 <2e-16 ***
---
The maximized loglikelihood is 313.8
Optimization converged
## Fitting Frank and Clayton copulas without R output

(UD.fc2 <- fitCopula(copula=frankCopula(3,dim=2), data=UD,
(UD.cc2 <- fitCopula(copula=claytonCopula(3,dim=2), data=UD,


## Compare the empirical copula with the estimated ones
## using simulations
> n <- nrow(UD)
## define the 4 copulas
> ht <- tCopula(param=UD.tc2@estimate[1], df=round(UD.tc2@estimate[2]))
> hg <- gumbelCopula(UD.gc2@estimate, dim=2)
> hf <- frankCopula(UD.fc2@estimate, dim=2)
> hc <- claytonCopula(UD.cc2@estimate, dim=2)
> par(mfrow=c(2,3))
## display data
> plot(UD, main="Data")
## simulate from the fitted copulas
> set.seed(4711)
> htr <- rCopula(n, ht); hgr <- rCopula(n, hg)
> hfr <- rCopula(n, hf); hcr <- rCopula(n, hc)
## display simulated data
> h.pplot <- function(x, main=""){
plot(x, main=main, xlab=expression(u[1]),ylab=expression(u[2]),
col=rgb(0,0,1, alpha=0.2), pch=16) }
> h.pplot(htr, main="From t copula")
> h.pplot(hgr, main="From Gumbel copula")
> h.pplot(hfr, main="From Frank copula”)
> h.pplot(hcr, main="From Clayton copula")
Which simulated copula is most similar to the data?
u1 <- UD[,1]; u2 <- UD[,2]
Udex <- (1:n)/(n+1) ##
h.l <- c(0.02, 0.05, 0.1, 0.2, 0.4, 0.6, 0.8, 0.9) ## contour levels
## The function 'C.n()' from package copula computes the empirical copula
Cn <- C.n(u=cbind(rep(Udex,n), rep(Udex,each=n)), U=UD, offset=0,method="C")
## prepare the contours of the empirical copula:
EmpCop <- expression(contour(Udex, Udex, matrix(Cn,n,n), col=2, add=T,
levels=h.l))
par(mfrow=c(2,3), las=1, mar=c(3.5,4,2,1), cex.lab=1.2, mgp=c(2.2,0.8,0))
## "raw" data
plot(u1, u2, main="Uniform...", xlab=expression(hat(U)[1]), ylab = expression(hat(U)[2]))
## t
contour(tCopula(param=UD.tc2@estimate[1], dim=2, df=round(UD.tc2@estimate[2])),
pCopula, main=expression(hat(C)[t]), levels=h.l, xlab=...)
eval(EmpCop)
## Frank
contour(frankCopula(param= UD.fc2@estimate[1], dim=2),
pCopula, main=expression(hat(C)[Fr]), levels=h.l, xlab=...)
eval(EmpCop)
## Clayton
contour(claytonCopula(param=UD.cc2@estimate[1], dim = 2),
pCopula, main=expression(hat(C)[Cl]), levels=h.l, xlab=...)
eval(EmpCop)
## Gumbel
contour(claytonCopula(param=UD.gc2@estimate[1], dim = 2),
pCopula, main = expression(hat(C)[Gu]), levels=h.l, xlab=...)
eval(EmpCop)
Assess the fit by AIC
Akaike’s information criterion AIC = -2log-likelihood + 2p
## with R
> h.AIC <- function(obj){
+ np <- length(obj@estimate)
+ h <- obj@loglik
+ c(loglik=h, AIC=-2*h+2*np)
}
> rbind(h.AIC(UD.tc2), h.AIC(UD.fc2), h.AIC(UD.gc2),
h.AIC(UD.cc2))
loglik AIC
[1,] 362.2008 -720.4016
[2,] 325.0530 -648.1059
[3,] 313.8293 -625.6587
[4,] 293.7249 -585.4498
## According to the AIC the t copula fits the data best

8.7* Vine Copula
• There is a wide range of parametric copula families (Gauss, t, Frank, Clayton, ...)
• But: Standard multivariate copulas
– can become inflexible in high dimensions.
– do not allow for different dependency structures between pairs of variables.
• → Way out: E.g., Vine copulas for higher-dimensional data
• Vine Copulas:
Copulas
The dependency structure is determined by bivariate copulas and a nested
set of trees. Example in d=3 dimensions:
– One possible decomposition of f(x1,x2,x3) is:
– Since
– We obtain

• The decomposition is not unique
• A graphical strucure called regular vine structure has been introduced to

help organize them:
• See also R Package ‘VineCopula’
• more research is needed, particularly towards application

Take Home Message Lecture 5
Copulas are a general concept to model dependencies between random

variables
• A copula is a multivariate cumulative distribution function (CDF) whose

univariate marginal distributions are all uniform (0,1)
• To use copulas to model multivariate dependencies, we need parametric

families of copulas
 Gaussian copula, t-copula,
Archimedean copulas (e.g., Frank, Gumbel and Clayton copulas)
• In finance, the feature of modelling tail dependence is an advantageous

characteristic of copulas  t-copula, Clayton copula, Gumbel copula
• Practically,
– use the introduced copulas mainly to model 2 dimensional r.v.
– vine copulas enables a flexible modelling of the dependence structure for
portfolios of large dimensions

• Lecture 5 in the books:
Chapter 8 Copulas
• Sections marked by * are not examined


05 WBL-SAoFD Lecture5

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

05 WBL-SAoFD Lecture5

Uploaded by

Copyright:

Available Formats

ETH Zürich, WBL Angewandte Statistik 2017

Prof. Dr. Andreas Ruckstuhl

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 1

• Lecture 1: Financial Data and Their Properties

The statistical analysis of multivariate Date is classically based on the

• As a consequence we need just to bother estimating

• The stochastic dependence between two normally distributed variables is

• To understand the relationship between variables, it is much better to

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 3

Most people use the correlation matrix for examination:

• The correlation coefficients is only a summary of the linear relationship between

• Interesting features, such as nonlinearity or the joint behaviour of extreme

• One sees little evidence of nonlinear relationships, but some structures

• This lack of nonlinearities is typical of returns on equities, but it should not be

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 5

Modelling multivariate distributions beyond normal distributions need an

A copula is a multivariate cumulative distribution function (CDF) whose

Remember: If Y has a continuous CDF F, then F(Y) has a Uniform(0,1)

– CY contains all information about dependencies among the

• For calibration we need an expression in terms of the joint density:

• The independence copula:

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 8

Using copulas to model multivariate dependencies,

→ The dependencies within Y is described by the correlation matrix Ω of Y

• The Gaussian copula with correlation matrix Ω will be denoted

• Example: Meta-Gaussian distribution for 2 dimensions:

where Φ-1() is the inverse of the standard Gaussian distribution and

• Margins: Gamma and beta distributed

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 10

Similarly, let be the copula of a multivariate t-distribution with

A distribution with a t-copula is called a t-meta distribution.

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 11

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 12

Notice that in (†), the value of C(u1, …, ud) is unchanged

One consequence of this property (called exchangeability) is:

 Archimedian copulas are most useful in the bivariate case or

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 13

→ bivariate Frank copula:

The Gumbel copula is the independent copula when θ=1

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 15

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 16

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 17

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 18

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 19

• Tail dependence measures association between the extreme values of

Lower Tail Dependence

P Y2 £ FY-2 1 (q ) and Y1 £ FY-11 (q )

• If Y1 and Y2 are independent, then

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 20

• For Gaussian and t-Copula,

• Knowing whether or not there is tail dependence is important for risk

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 21

• T-Copula with correlation ρ:

– Since Ft,ν+1(-∞) = 0, we see

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 22

– The Frank copula is not able to model either tail dependencies.

• Financial markets: losses occur more often jointly than gains do

A. Ruckstuhl -- WBL 2017, Lecture 5 of SAoFD -- Page 23

Assume that we have an i.i.d. sample

• An important task is choosing a copula model.

• A direct maximum likelihood estimation may be too challenging because

• A pseudo-maximum likelihood estimation may be more convenient.

is maximised over the parameter of the copula