Research Article

Received 30 May 2011, Revised 22 November 2012, Accepted 23 November 2012 Published online 7 January 2013 in Wiley Online Library

(wileyonlinelibrary.com) DOI: 10.1002/asmb.1960

Robust pair-copula based forecasts of

realized volatility
Beatriz Vaz de Melo Mendesa * † and Victor Bello Acciolyb
A useful application for copula functions is modeling the dynamics in the conditional moments of a time series. Using copulas, one
can go beyond the traditional linear ARMA.p; q/ modeling, which is solely based on the behavior of the autocorrelation function,
and capture the entire dependence structure linking consecutive observations. This type of serial dependence is best represented by
a canonical vine decomposition, and we illustrate this idea in the context of emerging stock markets, modeling linear and nonlinear
temporal dependences of Brazilian series of realized volatilities. However, the analysis of intraday data collected from e-markets
poses some specific challenges. The large amount of real-time information calls for heavy data manipulation, which may result in
gross errors. Atypical points in high-frequency intraday transaction prices may contaminate the series of daily realized volatilities,
thus affecting classical statistical inference and leading to poor predictions. Therefore, in this paper, we propose to robustly estimate
pair-copula models using the weighted minimum distance and the weighted maximum likelihood estimates (WMLE). The excellent
performance of these robust estimates for pair-copula models are assessed through a comprehensive set of simulations, from
which the WMLE emerged as the best option for members of the elliptical copula family. We evaluate and compare alternative
volatility forecasts and show that the robustly estimated canonical vine-based forecasts outperform the competitors. Copyright
© 2013 John Wiley & Sons, Ltd.

Keywords: pair-copula; realized volatility; robust estimation; serial dependence; nonlinear forecasts

1. Introduction

The analysis of intraday data collected from e-markets poses specific challenges. The large amount of real-time informa-
tion calls for heavy data manipulation, which may result in gross errors. Even a clever automatic cleaning will fail if not
all necessary conditions are set.
Contaminations may filter through from fake orders, storing, and the withdrawal of periods without trading activity; any
of these may induce the misalignment of multivariate data at specific time intervals, distorting estimates of the dependence
structure. In a univariate setting, such gross errors may damage the conditional marginal fits, causing harmful effects on
the autocorrelation values. Atypical points in high-frequency intraday transaction prices will be carried over to the series
of daily realized volatilities and will affect classical statistical inference, leading to poorer predictions.
In this paper, we extend the previous work of Mendes et al. [1] and study robust estimation for pair-copula models.
This extension is straightforward because a pair-copula construction is simply a hierarchical decomposition of a multi-
variate copula into a cascade of bivariate copulas. The estimation takes place at the level of two-dimensional data, thereby
avoiding the famous curse of dimensionality. We note that the copula sample space Œ0; 1d also poses difficulties for the
visual inspection of atypical points. Thus, we need an automatic robust procedure that would work well regardless of
whether data are contaminated or not.
In [1], two classes of robust estimators for copulas were proposed, each of which aiming to provide guidance for the
modeling of real data. They are based on either a redescending weight function or a hard rejection rule. The weighted
minimum distance estimators (WMDE) minimize selected weighted distances from the empirical copula, thus generating
a goodness-of-fit statistics. The weighted maximum likelihood estimates (WMLE) are generated by a two-step procedure.
In the first step, outlying data points are identified by a robust covariance estimator and receive zero weight. In the second
step, the MLE are computed for the reduced data.

a IM/COPPEAD, Federal University at Rio de Janeiro, Brazil

b COPPEAD, Federal University at Rio de Janeiro, Brazil
183

*Correspondence to: Beatriz Vaz de Melo Mendes, Rua Marquesa de Santos, 22, apt. 1204, Rio de Janeiro, 22221-080, RJ, Brazil.
† E-mail: beatriz@im.ufrj.br

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
 B. VAZ DE MELO MENDES AND V. B. ACCIOLY

We propose to robustly estimate pair copulas using WMDE and WMLE. For each pair-copula (that is, each set of
parametric bivariate copulas), a robust WMD or WML estimator may be determined among the 24 different options,
which provides less biased estimates under contamination scenarios. In addition, we derive the WMD and the WML
estimators for two important copula families in finance—BB7 and t -student—and the WMLE will again be proven the
best option for members of the family of elliptical copulas. In Section 2, we review pair-copula definitions and estimation
methods and introduce the robust estimators.
In addition to the primary task of linking a set of d (possibly completely different types of) random variables to form a
multivariate distribution, a copula function also has the useful application of modeling conditional dynamics within a time
series. This means that there is a copula representing the joint distribution of lagged variables forming a time series. Thus,
we may go beyond the linear ARMA.p; q/ models that are solely based on the behavior of autocorrelation functions.
To model the temporal dependence structure in a univariate time series x1 ; x2 ;    ; xT , instead of a set of variables,
we now consider the set of d series formed by lagged values of the original series, fxt gTt D1 d C1
, fxt gTt D2
d C2
;    ; fxt gTtDd ,
a modeling strategy proposed in [2] and further explored in [3–6].
Most of the existing literature on the copula modeling of first-order Markov processes is devoted to the theoretical
aspects of the problem. In [7], several examples are given regarding the construction and specification of Markov processes
using copulas. la Peña et al. [8] and Ibragimov [9] characterize higher-order Markov processes in terms of copulas.
Beare [5] obtains sufficient conditions for a geometric rate of mixing in stationary Markov chains using copula functions.
Inference has been considered in [10], where the estimation of a class of copula-based semiparametric stationary Markov
models was explored. Here, the asymptotic properties of these models were established under simple conditions, and root-n
consistent and asymptotically normal estimators of important features were obtained for the transition distribution. Chen
and Fan [11] considered the estimation of copula-based semiparametric strictly stationary Markov models and proposed
a sieve maximum likelihood estimation (MLE) for the copula parameter. Domma et al. [12] applied a full maximum
likelihood methodology in which marginal and association parameters were estimated simultaneously when analyzing
daily stock returns. Choros̀ et al. [13] reviewed parametric, semiparametric and nonparametric approaches to inference on
copulas for random samples with dependent marginals and copula-based time series.
In this paper, we conditionally model the time-varying behavior of realized volatilities series [14] in the Brazilian
equity market using pair-copulas. We examine the evolution over time of the seven most traded Brazilian stock volatilities.
Given the unique characteristics of the Brazilian market, we expect that the findings here can clarify the importance and
usefulness of these realized variances within other emerging markets.
We robustly estimate the canonical vine (C-vine) decomposition of the evolution of the volatility and use estimates
to forecast. To the best of our knowledge, such a modeling strategy based on pair-copulas, has not yet been applied to
a series of realized volatilities. Because an appropriate copula function can be found for any type of association—linear,
nonlinear, ranging from perfect negative to perfect positive dependence—an improvement can be expected over traditional
linear time series methods for modeling and forecasting. In [15], it is suggested that explicitly accounting for nonlinear
features in the realized volatility may result in better volatility forecasts. Another nonlinear alternative to the linear models
based on a discrete mixture of distributions is given in [16].
In summary, the contribution of this paper is threefold: (i) we introduce robust estimation for pair-copula models; (ii) we
model the serial dependence of the first moment of a time series, aimed at forecast using C-vines; and (iii) we illustrate
the modeling strategy given in (i) and the inference method given in (ii) using Brazilian-realized volatilities.
The remainder of this paper is organized as follows. In Section 2, we briefly review the definition of copulas and pair-
copulas, introduce the robust estimates, and report results from new simulations. In Section 3, we obtain the series of
realized volatility for the seven most traded Brazilian stocks and analyze their serial dependence. Out-of-sample forecasts
are evaluated and compared with those obtained from classical estimation of C-vines and to those obtained from a classical
linear AR(3) model. For the sake of comprehensiveness, D-vine based forecasts are also compared. Several criteria are
used to assess the performance of alternative forecasts, and we provide evidence that robustly estimated C-vine based
out-of-sample forecasts perform better than all other computed forecasts. In Section 4, we summarize and discuss the
findings of this paper.

2. Robust estimation for pair-copula models

Firstly, we provide a brief review of copulas and pair-copulas.

2.1. Copulas
The most important theorem in copula theory [17] dates back to the 1950s. It states that any multivariate distribution can
184

be expressed by its copula function evaluated at its marginal distribution functions.

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
B. VAZ DE MELO MENDES AND V. B. ACCIOLY

A d -dimensional copula C is a d -dimensional distribution function (c.d.f.) on Œ0; 1d with standard uniform marginal
distributions. Consider a continuous random vector X1 ; : : : ; Xd with joint c.d.f. H.x1 ; : : : ; xd / and marginal distributions
F1 ; : : : ; Fd . Sklar’s theorem ensures that there exists a d -copula C such that for all .x1 ; : : : ; xd / 2 Œ1; 1d

H.x1 ; : : : ; xd / D C.F1 .x1 /; : : : ; Fd .xd //: (1)

Conversely, if C is a d -copula and F1 ; : : : ; Fd are c.d.f.s, then the function H defined by (1) is a d -dimensional
distribution function with margins F1 ; : : : ; Fd . Furthermore, if all marginal c.d.f.s are continuous, then C is unique.
Given a joint c.d.f. H with continuous margins F1 ; : : : ; Fd , as in Sklar’s Theorem, it is easy to construct the
corresponding copula:

C.u1 ; : : : ; ud / D H.F1 .u1 /; : : : ; Fd .ud //; (2)

where Fi is the generalized inverse of Fi , that is, Fi .u/ D supft 2 < W Fi .t / 6 u; 0 6 u 6 1g. Formula (2) is the tool
for extracting the copula pertaining to a multivariate distribution.
When C is absolutely continuous, taking partial derivatives of (1) obtains
d
Y
h.x1 ;    ; xd / D c.F1 .x1 /;    ; Fd .xd // fi .xi / (3)
i D1

for some d -dimensional copula density c. This expression will prove useful later for parameter estimation. The formula (3)
allows for tailored marginal modeling and may consider all characteristics of each Fi , including the mean, standard
deviation, skewness, kurtosis and any type of short and long memory serial dependence, plus a search for the best fit
of the dependence structure through a large number of copula families that may be explored. This process results in
flexible multivariate distributions with any choice of marginal distributions. An important example is the family of the
meta-elliptical distributions [18, 19] which, unlike the family of elliptical distributions, does not impose any constraints
on the margins. This flexibility has motivated the applications of copulas in several research areas.

2.2. Pair-copulas
However, the copula approach for modeling high-dimensional data also has limitations. First, the generalization of
bivariate copulas to multivariate copulas of dimensions larger than 2 is not straightforward. When high-dimensional
copulas are available, there are significant obstacles to solving the required optimization problems over many dimensions,
and most of the available software deals only with bivariate cases. Even if we are able to fit a d -dimensional copula, d > 2,
parametric copula families usually restrict all pairs to having the same type or strength of dependence. For example, in
the case of the t -copula, a single parameter, the number of degrees of freedom, is used in addition to the correlation
coefficients to compute the coefficient of tail dependence for all pairs. This is a serious restriction because the dependence
structures among pairs of variables usually vary substantially, including changes in the copula family.
Pair-copulas, as a collection of potentially different bivariate copulas, are flexible and provide a closer approximation to
the true copula density. Their method of construction is hierarchical, and variables are sequentially incorporated into the
conditioning sets as one moves from level 1 (tree 1) to tree d  1. The bivariate copulas may vary freely, with respect to
the choice of parametric families and parameter values. Therefore, all types and strengths of dependence can be covered.
Pair-copulas are easy to estimate and simulate, making them very appropriate for modeling high-dimensional data sets.
The decomposition of a multivariate distribution in a cascade of pair-copulas was originally proposed in [2] and later
discussed in detail in [20–23].
Pair-copula estimation is usually performed in the context of independent and identically distributed observations by
extending the inference function for margins (IFM) method, that was initially proposed for the estimation of copula
parameters. Under the IFM method, introduced in [24], MLE are obtained for marginal and copula parameters. Joe [2]
argues that we can expect the IFM method to be quite efficient because it is fully based on MLE. The success of this
estimation procedure starts with good marginal fits [25] that typically pose no difficulties. Alternatively, a semiparametric
method may be applied, in which the margins are fitted empirically and the dependence parameters are fitted by maximum
likelihood. Confidence intervals are usually obtained through bootstrap methods, although for some families, the asymp-
totic variance may be computed. In this paper, we use the sequential approach (proposed in [23] and applied in [26])
in which the estimates from the previous tree are used to transform the data in the current tree. Precise recursions for
sequential estimation in C-vine models were given in [27].
Bayesian methods have also been applied to pair-copulas. In [28], Bayesian inference based on MCMC is proposed
185

for multivariate elliptical copulas using the inverse Wishart distribution as the prior distribution for the correlation matrix.

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
 B. VAZ DE MELO MENDES AND V. B. ACCIOLY

Min and Czado [29] also developed a Markov chain Monte Carlo algorithm that provides credibility intervals. In [27], a
very interesting data-driven sequential selection procedure is proposed or jointly choosing the C-vine structure and the
pair-copula families. A sequential estimation procedure for copula parameters in a previously specified C-vine was also
developed and implemented.
Consider again the joint distribution H and density h with strictly continuous marginal c.d.f.s F1 ;    ; Fd with densities
fi . First, note that any multivariate density function may be uniquely decomposed as

h.x1 ; : : : ; xd / D fd .xd /  f .xd 1 jxd /  f .xd 2 jxd 1 ; xd /    f .x1 jx2 ; : : : ; xd /: (4)

The conditional densities in Equation (4) may be written as functions of the corresponding copula densities. That is, for
every j

f .x j v1 ; v2 ;    ; vd / D cxvj jvj .F .x j vj /; F .vj j vj //  f .x j vj /; (5)

where vj denotes the d -dimensional vector v excluding the j th component. Note that cxvj jvj .; / is a bivariate marginal
copula density.
Decomposition (4) together with (5) was described in [30] and in [23]. Expressing all conditional densities in
Equation (4) by means of Equation (5), we derive a decomposition for h.x1 ;    ; xd / that consists of only univariate
marginal distributions and bivariate copulas. From (3), one obtains a factorization of the d -dimensional copula density
c.F1 .x1 /;    ; Fd .xd // based only on bivariate copulas, the pair-copula decomposition. This is a very flexible and
natural way of constructing a higher dimensional copula. Note that, given a specific factorization, there are many possible
reparametrizations. The conditional c.d.f.s necessary for pair-copulas construction are given [2] by
@Cx;vj jvj .F .x j vj /; F .vj j vj //
F .x j v/ D :
@F .vj j vj /
For large d , the number of possible pair-copula constructions is very large. In [20] and [21], a systematic method for
obtaining these decompositions, the so called regular vines, is introduced. These graphical models elucidate the conditional
specifications made for the joint distribution. Two special cases are the C-vines and the D-vines. A tree vine structure
of [20] and [21] was used in [23] to derive the density of a C-vine. A C-vine factors a density h.x1 ;    ; xd / in
d
Y 1 dY
dY j
f .xk / cj;j Ci j1;:::;j 1 .F .xj jx1 ; : : : ; xj 1 /; F .xj Ci jx1 ; : : : ; xj 1 //:
kD1 j D1 i D1

For a detailed description, see [23] and [30].

For the real-data illustration, we detail in Section 3, there is one key variable that interacts with all others. In such
situations, it is more convenient to choose a C-vine decomposition, placing this leading variable at the root of the C-vine.
Figure 1 shows the C-vine decomposition for d D 4. The C-vine consists of three nested trees, with tree Tj having 5  j
nodes, and 4  j edges, corresponding to a bivariate copula. The copulas in tree 1 are unconditional, whereas all others
are conditional.

t-1 t-2

C(t,t-1) C(t,t-2)

C(t,t-3)
t t-3

t , t-2

C(t-1,t-2|t)

C(t-1,t-3|t)
t , t-1 t , t-3

C(t-2,t-3|t,t-1)
t-1,t-2|t t-1,t-3|t
186

Figure 1. The canonical vine graphical hierarchical representation of a four-dimensional pair-copula.

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
B. VAZ DE MELO MENDES AND V. B. ACCIOLY

2.3. Robust estimates

When all data points come from the same data generating process, the MLE possess the usual favorable statistical
properties ([31] and [32]). However, the MLE becomes severely biased under contamination scenarios because of its
zero breakdown point ([33]).
We obtain robust estimates for pair-copulas by adapting the concept of WMDE and WMLE, originally proposed in
[1] for copulas, to the pair-copulas environment. A comprehensive simulation study showed that for each copula family,
a specific weighted minimum distance estimator can always be found, which does not depend on the sample size or the
strength of the dependence and is able to downweight the influence of contaminating points, thus achieving robustness.
For elliptical copulas, as expected, the WMLE is usually the best robust option. Under the true model, WeiB [34] and
Hering [35] proved consistency for the WMDE based on the empirical copula process by considering a two-step estimation
process. In [35], it was also shown that a canonical maximum likelihood procedure in high dimensions presents severe
computational problems.
Because the estimation of a pair-copula model is performed at the level of bivariate data, we review the definitions
of these estimators in the bivariate case. Details on these estimates may be found in [1]. Let d D 2 and let .X1;t ; X2;t /,
t D 1; : : : ; T , be T independent copies of .X1 ; X2 / with joint c.d.f. H . The bivariate empirical distribution function is
given by
T
1 X
HT .x1 ; x2 / D IfX 6x ;X 6x g ;  1 < x1 ; x2 < C1 ;
T t D1 1;t 1 2;t 2

where IfAg is the indicator function of event A. Its associated marginal empirical distribution functions Fi;T .x1 /, i D 1; 2,
are defined as

F1;T D HT .x1 ; C1/ and F2;T .x2 / D HT .C1; x2 / :


Let Fi;T e ([36–39]) is defined by
represent the generalized inverse of Fi;T . The empirical copula function C
  
e .u; v/ D HT F1;T
C 
.u/; F2;T .v/ ; 0 6 u; v 6 1 :
˚ t1 
According to Deheuvels [36], C e converges to C as T increases. C
e is computed on the lattice L D ; tT2 , where t1 and
T
t2 are integers, 1 6 t1 ; t2 6 T :
        
e t1 ; t2 D HT F1;T
C  t1 
; F2;T
t2
8
t1 t 2
; 2 L: (6)
T T T T T T
Let C represent a parametric copula parameterized by . The minimum distance estimator for  is the solution   that
minimizes over all  in the parameter space ‚, some distance between the empirical copula Ce and the parametric copula
b D C fitted to the data. Four selected distance statistics—the Kolmogorov statistic K, the Cramér–Von Mises statistic
C b

W 2 , the Anderson–Darling statistic (AD), and the Integrated Anderson–Darling statistic (IAD)—were further modified
through the application of different redescending weight functions, yielding 24 types of WMDE.
Examples of metrics defining the MDEs are the Kolmogorov statistic K
ˇ    ˇ
ˇ t1 t2 t1 t2 ˇˇ
K D  max ˇ e b
t1 t2 ˇC T ; T  C T ; T ˇ; (7)
; 2L
T T

and the Cramér–Von Mises statistic W 2

XT X T    
2
W2D e t 1 ; t2  C
C b t1 ; t2 : (8)
t D1 t D1
T T T T
1 2

By applying to (7) and (8) the weight function

1
wAK D rh ; (9)
 t1 t2  h
i  t1 t2 i
b
C T;T b
1C T ; T
187

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
 B. VAZ DE MELO MENDES AND V. B. ACCIOLY

which emphasizes deviations in the tails (the corners of the unit square), one obtains the so called Anderson–Darling
statistic (10)
ˇ  ˇ
ˇ e t1 t2  b  t1 t2 ˇ
ˇ C ;
T T
 C T T ˇ
;
ADAK D  max rh i h ; (10)
t1 t2  t1 t2   t1 t2 i
T ; T 2L b
C T;T b
1C T ; T

and the Integrated Anderson–Darling statistic (11)

h    i2
T X
X T e t1 ; t2  C
C b t1 ; t2
T T T T
IAD AK D h  ih  i : (11)
b 1 2
t t
t1 D1 t2 D1 C T ; T
b t1 ; t2
1C T T

New redescending weight functions emphasizing different regions of the Œ0; 12 were proposed in [1] and resulted in
other robust variations of the Kolmogorov and Cramér–Von Mises statistics. For example, the weight function w1;LLUR
 
t 1 t2 1
w1;LLUR ; D rh ; (12)
T T  i h  i
t1
C t2
 b t1 ; t2
C 1  b t1 ; t2
C
T T T T T T

h  i
emphasizes just the points in the lower left (LL) and upper right (UR) corners. The factors tT1 C tT2  C b t1 ; t2 and
T T
h  t1 t2 i
1C b ; correspond to the c.d.f. areas located at the LL and the UR quadrants of the unit square. By applying w1
T T
to (7) and (8), one obtains
     
t1 t2 b t1 ; t2 j w1;LLUR t1 ; t2 ;
AD 1 D max j CQ ; C (13)
16t1 ;t2 6T T T T T T T

XT X T    
 

Q t 1 t2 b t1 t 2 2 t1 t 2 2
IAD 1 D C ; C ; w1;LLUR ; : (14)
t D1 t D1
T T T T T T
1 2

The AD1 and the IAD1 estimators proved useful for the new classes of copulas investigated in this paper.
The WMLE consists of a weighted robustification of the MLE computed in two steps. In the first step, atypical points
are identified through the computation of a high breakdown point covariance matrix estimator. There are many high break-
down point estimators of multivariate location and scatter that could be used in this preliminary phase. In the application
worked out in Section 3, we use the robust Stahel–Donoho scatter matrix estimator based on projections [40, 41] that are
implemented in the free R software. Zero weight is given to any point with statistical distance to the center of the ellipsoid
greater than some cutoff point (the 0.95-quantile of a chisquare random variable). In the second step, a parametric copula
family is fitted to the points defined by the hard rejection rule. Note that no particular distributions (marginal or copula)
were assumed for the data.

2.4. Simulations
Because of their importance when modeling financial instruments, we now assess through simulations the performance of
the robust estimators for the elliptical t -student and the Archimedean BB7 (notation of [2]) parametric copula families.
The estimators are compared with the MLE, and their relative efficiency is assessed by means of their mean squared error
(MSE) from the Monte Carlo simulations. Under the true model, robust estimates are expected to possess small bias but
large variance compared with the MLE. However, the simulations showed that for the majority of the scenarios considered,
there is a robust estimate possessing very small bias and variance that outperforms the MLE.
The simulations scheme is described by the following. We considered -contaminated models, where a proportion  of
randomly chosen observations was replaced by “atypical” ones generated from a point mass contaminating distribution
F  . For each experiment, there were five possibilities for the location of the contaminating distribution F  : the center
of the unit square (C1) and the regions near the four corners (C2, lower left; C3, lower right; C4, upper right; and C5,
upper left). Thus, for each copula family, there are at least two locations where the contaminating points may actually be
188

considered atypical and could be visually spotted. The contaminating points at these locations were supposed to weaken

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
B. VAZ DE MELO MENDES AND V. B. ACCIOLY

the true strength of the dependence. At other locations, they had the potential to enhance the true strength of dependence.
Having fixed a copula family and the other simulation variables, all five possibilities were considered and investigated, and
the worst possible contaminating scenarios were covered. We set  equal to 0% , 5%, and 10%, and set F  as the bivariate
normal distribution, with correlation coefficient  D 0:00 and a very small variance. The contaminated data generation
process was monitored such that points falling outside the unit square were discarded.
Three sample sizes (50, 100, and 300) were considered, and the number of repetitions for each one was 1000. The
copula parameters were set such that the Kendall’s  correlation coefficient would be equal to 0:75, 0:50, 0:25 and 0:00.
For each experiment considered, we computed the MLE, the WMLE, and all of the 24 WMDE, reporting the results in
Tables I through IV.
First, we provide in Table I a summary of the results, showing the three winners for each copula family. The simulated
experiments indicated that for each copula family, there was at least one robust estimate performing very well, as measured
by its small mean squared error, despite the contamination percentage, contamination location, and sample size. As
expected, the accuracy of all estimators increased with sample size.
t -student copula: Tables II and III show the results for the t -copula under small (50) and large (300) sample sizes, as well
as for  D 0:0 and  D 0:05. The results for  D 0:10 are similar to those for  D 0:05, and the results for moderate
samples (100) are similar to those for large samples. We considered two values for the number of degrees of freedom
, namely 6 and 9, which are typically obtained in financial returns. The simulations revealed that the parameter  was
less affected by contamination and that the choice of  had little impact on the results of the simulations. Thus, we only
report the results for the correlation coefficient  in the case  D 9, providing the mean value and the MSE for the MLE,
the WMLE, and the three best WMDE estimators.
Under circumstances with no contamination, the MLE is the best estimator, followed closely by the WMLE and the
AD1 estimators. Under contaminated circumstances in which the contaminating points strengthen the true orientation of
the dependence (C2 and C4 locations), the MLE is less biased but possesses larger variability. When the contamination
location is either C3 or C5, the best options are the WMLE and the AD1 estimators, as the MLE is severely affected by
the outliers.

Table I. Summary of results from simulations for bivariate copulas.

Copula Copula type L U No contamination Contamination
Small SS–Large SS Small SS–Large SS
p p
t -student Elliptical MLE or AD1 WMLE or AD1
p
Gumbel Archimedean/EV MLE or IAD1 WMLE or AD1 or URAD1
p p
BB7 Archimedean MLE or IAD1 WMLE or IAD1
Notation in table: SS, Sample Size.
Winners under true and contaminated models.

Table II. t-student -contaminated bivariate copula models with  D 0:00.

 D 0:00 Sample size = 50  D 0:924  D 0:75
Estimator MLE WMLE AD1 IAD IAD1
Mean (MSE) 0.926 (0.003) 0.932 (0.005) 0.916 (0.005) 0.915 (0.007) 0.914 (0.007)

 D 0:00 Sample size D 300  D 0:924  D 0:75

Estimator MLE WMLE AD1 IAD W
Mean (MSE) 0.925 (0.001) 0.928 (0.001) 0.919 (0.001) 0.919 (0.002) 0.917 (0.002)

 D 0:00 Sample size D 50  D 0:383  D 0:25

Estimator MLE WMLE AD1 W AD
Mean (MSE) 0.387 (0.016) 0.394 (0.020) 0.375 (0.019) 0.374 (0.019) 0.374 (0.019)

 D 0:00 Sample size D 300  D 0:383  D 0:25

Estimator MLE WMLE AD1 AD IAD1
Mean (MSE) 0.386 (0.011) 0.387 (0.013) 0.379 (0.013) 0.378 (0.013) 0.377 (0.014)
Mean and mean squared error (MSE) of the maximum likelihood estimates (MLE), weighted maximum likelihood estimates (WMLE), and
189

three best weighted minimum distance estimators (WMDE) from 1000 simulations.

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
 B. VAZ DE MELO MENDES AND V. B. ACCIOLY

Table III. t-student -contaminated bivariate copula models with  D 0:05.

Contamination location: C1 (center)  D 0:924  D 0:75
Estimator MLE WMLE AD1 IAD IAD1
SS D 50 Mean (MSE) 0.948 (0.004) 0.959 (0.005) 0.911 (0.007) 0.911 (0.007) 0.908 (0.007)
Estimator MLE WMLE AD1 IAD W
SS D 300 Mean (MSE) 0.929 (0.002) 0.941 (0.002) 0.916 (0.002) 0.916 (0.002) 0.915 (0.003)

Contamination location: C2 or C4 (LR or UL)  D 0:924  D 0:75

Estimator MLE WMLE AD1 IAD W
SS D 50 Mean (MSE) 0.953 (0.009) 0.968 (0.007) 0.941 (0.008) 0.943 (0.009) 0.944 (0.009)
Estimator MLE WMLE AD1 IAD W
SS D 300 Mean (MSE) 0.947 (0.007) 0.948 (0.006) 0.931 (0.007) 0.932 (0.008) 0.933 (0.008)

Contamination location: C3 or C5 (LR or UL)  D 0:924  D 0:75

Estimator MLE WMLE AD1 IAD W
SS D 50 Mean (MSE) 0.416 (0.301) 0.929 (0.006) 0.921 (0.005) 0.921 (0.006) 0.920 (0.008)
Estimator MLE WMLE AD1 IAD W
SS D 300 Mean (MSE) 0.702 (0.033) 0.926 (0.003) 0.922 (0.003) 0.922 (0.003) 0.922 (0.004)

Contamination location: C1 (center)  D 0:383  D 0:25

Estimator MLE WMLE AD1 IAD IAD1
SS D 50 Mean (MSE) 0.477 (0.006) 0.481 (0.005) 0.370 (0.006) 0.360 (0.008) 0.350 (0.008)
Estimator MLE WMLE AD1 IAD W
SS D 300 Mean (MSE) 0.404 (0.005) 0.391 (0.004) 0.380 (0.005) 0.370 (0.007) 0.370 (0.007)

Contamination location: C2 or C4 (LL or UR)  D 0:383  D 0:25

Estimator MLE WMLE AD1 IAD W
SS D 50 Mean (MSE) 0.509 (0.006) 0.510 (0.006) 0.379 (0.007) 0.379 (0.008) 0.377 (0.008)
Estimator MLE WMLE AD1 IAD W
SS D 300 Mean (MSE) 0.413 (0.006) 0.414 (0.006) 0.0.381 (0.007) 0.381 (0.007) 0.380 (0.008)

Contamination location: C3 or C5 (LR or UL)  D 0:383  D 0:25

Estimator MLE WMLE AD1 IAD W
SS D 50 Mean (MSE) 0.012 (0.155) 0.381 (0.006) 0.381 (0.007) 0.380 (0.008) 0.380 (0.008)
Estimator MLE WMLE AD1 IAD W
SS D 300 Mean (MSE) 0.016 (0.104) 0.382 (0.005) 0.382 (0.006) 0.382 (0.007) 0.381 (0.007)
Mean and mean squared error (MSE) of the maximum likelihood estimates (MLE), weighted maximum likelihood estimates (WMLE), and
three best weighted minimum distance estimators (WMDE) from 1000 simulations and two sample sizes (SS).

BB7 copula: Table IV shows a summary of the results for the BB7 copula for  D 0:50 and  D 0:25, sample sizes of
300, under the circumstances of no contamination and for  D 0:05. When  D 1:9 and ı D 1:12, we obtain  D 0:50;
when  D 1:19 and ı D 0:46, we obtain  D 0:25 (that is, not unique solutions). As expected, under contaminated
circumstances, the MLE breaks down. We observe the excellent performance of the IAD1 under all scenarios.

Following a suggestion from a reviewer, we now assess the performance of robust estimates under -contaminated
C-vine models. We consider d D 4 and the following C-vine decomposition. In tree 1, the copula family (true parameter
values) are the Gumbel (ı D 2:10), Gumbel (ı D 1; 70) and Gumbel (ı D 1:60). The t -student ( D 0:5,  D 9) and the
Normal ( D 0:3) copulas compose tree 2, and finally, a Normal ( D 0:5) copula is considered in tree 3.
We set the sample size as 300 and place the contaminating points at the worst location C3. Four different experiments
were designed according to the copulas chosen to be contaminated. Experiments 1 through 3 contaminate each of the
unconditional copulas in tree 1, one at a time. Experiment 4 contaminates all three unconditional copulas in tree 1. We
report in Table V the classical MLE and the robust WMLE, AD1 , and IAD1 point estimates, as well as the MSE, in the
cases where  D 0:00 and 0:05.
The results of the simulations additionally provided an estimate for the proportion of times the classical estimation
method has broken down. We define breakdown whenever a positive tail dependence coefficient is estimated as zero, or
the other way around. For example, whenever the best fit at any stage of the estimation process has changed from a copula
190

possessing tail dependence (a Gumbel) to a copula with no tail dependence (a Normal or Frank). For the four experiments

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
B. VAZ DE MELO MENDES AND V. B. ACCIOLY

Table IV. BB7 -contaminated bivariate copula models.

 D 0:00 SS D 300  D 0:50  D 1:90 ı D 1:12
Estimator MLE WMLE IAD1 AD1 AD
 Mean (MSE) 1.914 (0.047) 2.074 (0.093) 1.867 (0.072) 1.889 (0.080) 1.881 (0.079)
ı Mean (MSE) 1.084 (0.091) 1.271 (0.195) 1.102 (0.118) 1.085 (0.112) 1.095 (0.115)
 D 0:00 SS D 300  D 0:25  D 1:19 ı D 0:46
Estimator MLE WMLE AD1 IAD1 IAD
 Mean (MSE) 1.196 (0.013) 1.209 (0.016) 1.199 (0.019) 1.189 (0.020) 1.188 (0.018)
ı Mean (MSE) 0.468 (0.026) 0.490 (0.034) 0.472 (0.038) 0.475 (0.037) 0.472 (0.040)
Contamination location: C3 or C5 (LR or UL)  D 0:05 SS D 300  D 0:50  D 1:90 ı D 1:12
Estimator MLE WMLE IAD1 AD2 IAD2
 Mean (MSE) 1.362 (0.299) 2.036 (0.089) 1.690 (0.128) 1.618 (0.157) 1.687 (0.197)
ı Mean (MSE) 0.355 (0.607) 1.250 (0.113) 0.986 (0.167) 0.987 (0.199) 0.896 (0.231)
Contamination location: C3 or C5 (LR or UL)  D 0:05 SS D 300  D 0:25  D 1:19 ı D 0:46
Estimator MLE WMLE IAD IAD1 IAD2
 Mean (MSE) 1.042 (0.019) 1.128 (0.017) 1.084 (0.019) 1.083 (0.019) 1.081 (0.020)
ı Mean (MSE) 0.123 (0.125) 0.331 (0.090) 0.312 (0.073) 0.298 (0.073) 0.297 (0.065)
Mean and mean squared error (MSE) of the maximum likelihood estimates (MLE), weighted maximum likelihood estimates (WMLE), and
three best weighted minimum distance estimators (WMDE) from 1000 simulations.

Table V. Canonical vine (C-vine) -contaminated pair-copula models.

C-vine Decomposition
.t; t  1/ .t; t  2/ .t; t  3/ .t  1; t  2jt / .t  1; t  3jt / .t  2; t  3jt; t  1/
Gumbel (2.1) Gumbel (1.7) Gumbel (1.6) t -student (0.5,9) Normal (0.3) Normal (0.5)
Estimator  D 0:00
MLE 2.105 (0.011) 1.705 (0.007) 1.603 (0.006) 0.498 (0.002) 0.301 (0.003) 0.498 (0.002)
WMLE 2.291 (0.061) 1.799 (0.024) 1.671 (0.016) 0.474 (0.003) 0.277 (0.004) 0.491 (0.002)
AD1 2.099 (0.022) 1.703 (0.012) 1.604 (0.009) 0.511 (0.003) 0.302 (0.004) 0.500 (0.003)
IAD1 2.105 (0.019) 1.702 (0.011) 1.601 (0.008) 0.496 (0.003) 0.299 (0.003) 0.497 (0.002)
Estimator  D 0:05 Contamination location: C3 of copula.t; t  1/
MLE 1.485 (0.380) 1.455 (0.064) 1.394 (0.046) 0.549 (0.004) 0.404 (0.013) 0.527 (0.003)
WMLE 2.242 (0.045) 1.612 (0.022) 1.503 (0.019) 0.491 (0.003) 0.289 (0.004) 0.530 (0.003)
AD1 1.529 (0.332) 1.491 (0.051) 1.437 (0.032) 0.585 (0.009) 0.412 (0.016) 0.499 (0.003)
IAD1 1.625 (0.233) 1.597 (0.020) 1.517 (0.014) 0.551 (0.005) 0.375 (0.009) 0.496 (0.003)
Estimator  D 0:05 Contamination location: C3 of copula.t; t  2/
MLE 1.699 (0.166) 1.303 (0.159) 1.394 (0.046) 0.599 (0.011) 0.43 (0.019) 0.469 (0.003)
WMLE 2.045 (0.026) 1.768 (0.018) 1.502 (0.019) 0.498 (0.003) 0.322 (0.004) 0.496 (0.002)
AD1 1.683 (0.185) 1.374 (0.111) 1.438 (0.032) 0.629 (0.019) 0.408 (0.015) 0.512 0.003)
IAD1 1.920 (0.046) 1.406 (0.091) 1.519 (0.014) 0.563 (0.006) 0.377 (0.009) 0.519 (0.003)
Estimator  D 0:05 Contamination location: C3 of copula.t; t  3/
MLE 1.682 (0.162) 1.455 (0.065) 1.256 (0.121) 0.592 (0.010) 0.401 (0.029) 0.450 (0.004)
WMLE 2.047 (0.025) 1.615 (0.024) 1.636 (0.012) 0.518 (0.003) 0.298 (0.004) 0.502 (0.002)
AD1 1.686 (0.179) 1.488 (0.054) 1.321 (0.081) 0.593 (0.011) 0.487 (0.038) 0.502 (0.003)
IAD1 1.926 (0.042) 1.597 (0.022) 1.351 (0.067) 0.557 (0.005) 0.391 (0.012) 0.506 (0.002)
Estimator  D 0:05 Contamination located at copulas.t; t  1/, .t; t  2/ and .t; t  3/
MLE 1.485 (0.381) 1.304 (0.159) 1.254 (0.121) 0.659 (0.026) 0.555 (0.066) 0.499 (0.002)
WMLE 2.249 (0.046) 1.770 (0.019) 1.644 (0.012) 0.479 (0.003) 0.282 (0.004) 0.494 (0.002)
AD1 1.529 (0.330) 1.375 (0.110) 1.327 (0.078) 0.705 (0.043) 0.602 (0.093) 0.545 (0.005)
IAD1 1.625 (0.231) 1.407 (0.090) 1.347 (0.068) 0.586 (0.009) 0.420 (0.017) 0.560 (0.006)
Mean and mean squared error (MSE) of the maximum likelihood estimates (MLE), weighted maximum likelihood estimates (WMLE),
191

Anderson–Darling statistic (AD1 ) and Integrated Anderson–Darling statistic (IAD1 ) estimates from 1000 simulations.

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
 B. VAZ DE MELO MENDES AND V. B. ACCIOLY

containing outliers, this observed proportion was quite high, 39%, 33%, 31% and 37%, respectively, all of which are
absolutely in line with the lack of robustness in classical MLE possessing zero as an asymptotic breakdown point.
Under circumstances with no contamination, all robust estimators presented very little bias, although, as expected,
the MLE showed a smaller MSE. Under contaminated circumstances , the MLE still shows small MSE values, but this
comparison is unfair because the computations involving the MLE consider only those runs in which the classical estimate
did not break down. Under contamination, the WMLE is less biased but possesses higher standard errors. We note the
excellent performance of the WMDE under all scenarios.
In summary, the results in Tables I though V show that under circumstances with no contamination, the MLE is the best
estimator; however, there is always a robust estimate that performs almost as well. Whenever the classical and the robust
estimates strongly disagree, one should search for contaminations and consider using the robust ones.

3. Robust forecast of realized volatilities

Although not directly observable, volatility is a key variable in risk management and plays an important role when pricing
options, composing portfolios, and computing risk measures. Ex-post realized volatilities may be constructed by summing
the squares of evenly spaced intraday high-frequency returns computed from continuously recorded transaction prices [42].
Papers dealing with the construction and applications of realized volatilities have generally focused on developed market
data ([43, 44], among others).
Being estimated, volatility suffers from many sources of uncertainty, including model specification and parameters
estimation. The realized volatility is an unbiased and highly efficient model free measure of the ex-post return variability
computed from high-frequency intraday returns. For any fixed day, the realized variance may be simply defined as the sum
of the squared high-frequency intraday returns (see theoretical details in [14, 42, 45, 46]).
High-frequency data possess unique characteristics that are not present in low frequency data (daily, weekly, and
monthly) and t calls for specific data treatments. Transactions with variable volumes occur in irregular time space, and
their data show seasonal and variable market activity patterns throughout the day. Thus, there may be asynchronicity in
the data, and the bid-ask bounce effect may distort inferences. All of these features make their statistical analysis more
interesting. On the other hand, the number of observations is huge, increasing the chances of many types of errors such as
transaction and recording errors.
In this section, we examine the time-varying behavior of the daily equity return-realized volatilities obtained from high-
frequency returns computed from continuously recorded transaction prices of the seven most traded Brazilian stocks
(PETR4 (Petrobras), VALE5 (Vale), TNLP4(Telemar), USIM5 (Usiminas), BBDC4 (Bradesco), CSNA3 (Siderúrgica
Nacional) and ITAU4 (Itauunibanco)), as provided by BOVESPA, covering the 20-month period from 03 September
2007 through 30 April 2009. Each data record is similar to the “Trades and Quotes” provided by the NYSE and contains
the complete information on transactions and quotes for a financial asset.
To eliminate the impacts of the changes in the BOVESPA closing time (summer time), the data were first expressed in
the Greenwich mean time format. For data alignment at fixed time intervals, instead of the common practice denominated
before‡ , we obtain the volume-weighted average price (VWAP). The VWAP gives rise to a smaller realized variance, as it
is closest to the efficient price instead of to the closing price.
We divide the 7-h trading period into 84 -intervals, D 5 min, which are considered small enough to guarantee
the asymptotic unbiased property of the estimator but sparse enough to incorporate and mitigate the microstructure noise
(a recent vein of research suggests the alternative inclusion of a noise term in the intraday price process). Let Pt  ;k and
Qt  ;k , k D 1;    ; n, represent the kth price and volume for a Brazilian stock during a -interval, t  D 5; 10;    ; 420.
The real value log price pt  of this stock for each 5-min time interval is given by
 
Pt  ;1  Qt  ;1 C Pt  ;2  Qt  ;2 C    C Pn  Qt  ;n
pt D ln
 : (15)
Qt  ;1 C Qt  ;2 C    C Qt  ;n
The 5-min intraday continuously compounded return rt  on this stock from time .t   / to t  is computed as
rt  D pt   pt   : (16)
Intraday data may present seasonality and volatility clusters. To eliminate the noise due to microstructure effects, an
ARMA.p; q/ filter may be fitted to the intraday returns before computing the realized volatility. Let rt  (still) denote the
filtered data.
192

‡
“Before” makes use of the most recent observation, or the closest, with respect to the desired minute and obtains the average of the bid-ask values
through a linear interpolation of the log-price.

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
B. VAZ DE MELO MENDES AND V. B. ACCIOLY

The realized variance (RVt ) at day t , t D 1; : : : ; T is defined as

X
RV t D rt2 :
t  2 day t

The realized volatility (RVolt ) and the log-realized volatility (RLVolt ) at day t are, respectively,
p
RVolt D RVt and RLVolt D ln .RVolt /:

As they are considered directly observable, these series are used to obtain better volatility forecasts based on simple
time series models. Our approach is to model the temporal dependence of the realized volatility at day t on the past
values at days t  1, t  2;    using robustly estimated pair-copula models. Applying robust estimates in this context
seems promising because of the large amount of data and extensive data manipulation that may increase the proportion of
atypical values, thereby increasing the bias of the predictions. Out-of-sample forecasts obtained from classical and robust
pair-copulas estimation are compared with classical linear autoregressive model (AR.p/).
We split the data in two parts, one for estimation (initial 19 months, 388 observations) and one for the computation
of the one-step-ahead out-of-sample predictions (the most recent month, April 2009, with 20 observations). Because of
the huge right asymmetry of the data and relying on the fact that copula functions are invariant under strictly increasing
transformations, we continue the analysis using the RLVol series. The sample autocorrelation functions as well as scatter
plots indicate that the RLVol at times t  1, t  2, and t  3 could be used to explain the behavior of the series at time t .
Thus, the observation at time t is a leading term that defines the three bivariate unconditional copulas in tree 1 of the
C-vine. The four-dimensional data are composed of the original and lagged series of RLVol.
We follow a two-step estimation approach. In the first step, we look for the distribution that best represents the univariate
series of RLVol. The values of the skewness and kurtosis coefficients (not shown here but available to the reader by request)
suggest using a skew-t distribution [4, 47, 48]. We fit by maximum likelihood a skew-t distribution to the 19-month series
of daily LRVol and from the estimated c.d.f., and we obtained pseudo uniform .0; 1/ data. Marginal fits were carefully
checked because a poor fit would result in probability integral transformed values being neither uniform nor i.i.d.. As a
consequence, any copula model would be misspecified.
Three unconditional and three conditional copulas compose the C-vine. A selection among the parametric copula
families was made after examining the uniform data scatter plots (an example is given in Figure 2). It became clear
from the plots that we should include copulas possessing upper and lower tail dependence, upper tail dependence alone,
and nonexchangeable dependence. Thus, we considered as possible candidates the BB7, BB1, Clayton, Survival Clayton,
Gumbel, and Tawn copulas, along with the two important members of the elliptical copulas, the Gaussian and the t -student
copulas. For the sake of completeness and for testing, we also considered the product copula. At each estimation tree, we
again examined the corresponding scatter plots to assess the adequacy of the families chosen and considered other families,

Empirical copulas at the baseline Mar/31/2009 (First row: Petrobras. Second row: Itau)
0.8

0.8

0.8
Time t-2
Time t-1

Time t-3
0.4

0.4
0.4
0.0

0.0
0.0

0.0 0.4 0.8 0.0 0.4 0.8 0.0 0.4 0.8

Time t Time t Time t
0.8

0.8

0.8
Time t-2

Time t-3
Time t-1
0.4

0.4
0.4

0.0
0.0

0.0

0.0 0.4 0.8 0.0 0.4 0.8 0.0 0.4 0.8

Time t Time t Time t

Support set for the empirical copulas in tree 1 of the canonical vine. PETROBRAS LRVol in first row and ITAU LRVol in
193

Figure 2.
the second row.

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
 B. VAZ DE MELO MENDES AND V. B. ACCIOLY

such as the Frank copula. For each pair-copula estimation (each bivariate copula fit), all nine candidates were estimated
and the best fit was indicated by the penalized log likelihood (AIC) value. After the quality of the fit through a pp-plot
based on the estimated and the empirical copula was visually checked, a formal goodness-of-fit test statistic based on
probability integral transformation and suggested in [23] was computed. An overview on goodness-of-fit testing in copula
models may be seen in [49].
The pair-copula decomposition for the PETROBRAS RLVol, along with the best classical and robust fits with parameter
estimates (standard errors) and tail dependence coefficients (L and U ), are shown in Table VI. All parameter estimates

Table VI. Best classical and robust canonical vine fits along with their copula families, parameters estimates, (standard errors),
and tail dependence coefficients (L ; U ) for the PETROBRAS, ITAU, VALE RLVol.
PETROBRAS
Classical Robust
Tree 1 .t; t  1/ .t; t  2/ .t; t  3/ .t; t  1/ .t; t  2/ .t; t  3/
Gumbel .ı/ Gumbel .ı/ Gumbel .ı/ Gumbel .ı/ Gumbel .ı/ Gumbel .ı/
1.96 (0.08) 1.68 (0.07) 1.56 (0.05) 2.19 (0.07) 1.85 (0.07) 1.64 (0.06)
(0, 0.58) (0, 0.49) (0, 0.44) (0, 0.63) (0, 0.55) (0, 0.47)
Tree 2 .t  1; t  2 j t / .t  1; t  3 j t / .t  1; t  2 j t / .t  1; t  3 j t /
t -student.; df / t -student.; df / t -student.; df / t -student.; df /
0.48 (0.04), 6 (1.1) 0.33 (0.04), 7 (1.1) 0.45 (0.04), 8 (1.1) 0.30 (0.03), 6 (0.9)
(0.16, 0.16) (0.08, 0.08) (0.10, 0.10) (0.09, 0.09)
Tree 3 .t  2; t  3 j t; t  1/ .t  2; t  3 j t; t  1/
t -student.; df / t -student.; df /
0.46 (0.04), 8 (1.2) 0.45 (0.04), 6 (1.1)
(0.10, 0.10) (0.15, 0.15)

ITAU
ClassicaL Robust
Tree 1 .t; t  1/ .t; t  2/ .t; t  3/ .t; t  1/ .t; t  2/ .t; t  3/
Gumbel .ı/ Gumbel .ı/ Gumbel .ı/ Gumbel .ı/ Gumbel .ı/ Gumbel .ı/
2.09 (0.09) 1.78 (0.07) 1.69 (0.07) 2.32 (0.08) 2.04 (0.08) 1.84 (0.07)
(0, 0.61) (0, 0.52) (0, 0.49) (0, 0.65) (0, 0.59) (0, 0.54)
Tree 2 .t  1; t  2 j t / .t  1; t  3 j t / .t  1; t  2 j t / .t  1; t  3 j t /
t -student.; df / t -student.; df / Normal./ Gumbel .ı/
0.51 (0.08), 10 (1.0) 0.35 (0.05), 9 (1.1) 0.48 (0.03) 1.26 (0.05)
(0.08, 0.08) (0.05, 0.05) (0.0,0.0) (0.0, 0.26)
Tree 3 .t  2; t  3 j t; t  1/ .t  2; t  3 j t; t  1/
t -student.; df / Normal./
0.47 (0.06), 13 (1.4) 0.43(0.03)
(0.04, 0.04) (0.0, 0.0)

VALE
Classical Robust
Tree 1 .t; t  1/ .t; t  2/ .t; t  3/ .t; t  1/ .t; t  2/ .t; t  3/
Gumbel .ı/ Gumbel .ı/ Gumbel .ı/ Gumbel .ı/ Gumbel .ı/ Gumbel .ı/
2.01 (0.08) 1.70 (0.07) 1.62 (0.06) 2.21 (0.08) 1.78 (0.06) 1.72 (0.06)
(0, 0.60) (0, 0.50) (0, 0.47) (0, 0.63) (0, 0.53) (0, 0.50)
Tree 2 .t  1; t  2 j t / .t  1; t  3 j t / .t  1; t  2 j t / .t  1; t  3 j t /
t -student.; df / Normal./ t -student.; df / t -student.; df /
0.52 (0.03), 9(0.8) 0.34 (0.04) 0.51 (0.03), 7 (0.6) 0.29 (0.04), 9(1)
(0.0, 0.11) (0.0, 0.0) (0.14,0.14) (0.04, 0.04)
Tree 3 .t  2; t  3 j t; t  1/ .t  2; t  3 j t; t  1/
Normal./ t -student.; df /
0.51 (0.03) 0.50 (0.03), 8 (1)
194

(0.0, 0.0) (0.12, 0.12)

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
B. VAZ DE MELO MENDES AND V. B. ACCIOLY

Table VII. Best classical and robust D-vine fits along with their copula families, parameters estimates, (standard errors), and tail
dependence coefficients (L ; U ) for the PETROBRAS RLVol.
Classical Robust
Tree 1 .t; t  1/ .t  1; t  2/ .t  2; t  3/ .t; t  1/ .t  1; t  2/ .t  2; t  3/
Gumbel .ı/ Gumbel .ı/ Gumbel .ı/ Gumbel .ı/ Gumbel.ı/ Gumbel .ı/
1.96 (0.08) 1.96 (0.08) 1.96 (0.08) 2.19 (0.09) 2.19 (0.09) 2.19 (0.09)
(0, 0.58) (0, 0.58) (0, 0.58) (0, 0.63) (0, 0.63) (0, 0.63)

Tree 2 .t; t  2 j t  1/ .t  1; t  3 j t  2/ .t; t  2 j t  1/ .t  1; t  3 j t  2/

t -student.; df / t -student.; df / t -student.; df / t -student.; df /
0.19 (0.05), 7 (1.1) 0.19 (0.05), 7 (1.1) 0.27 (0.05), 8 (1.1) 0.24 (0.04), 7(1.0)
(0.05, 0.05) (0.05, 0.05) (0.05, 0.05) (0.06, 0.06)

Tree 3 .t; t  3 j t  1; t  2/ .t; t  3 j t  1; t  2/

Normal./ Frank.ı/
0.12 (0.05) 0.53 (0.31)
(0.0, 0.0) (0.0, 0.0)

were highly statistically significant. The outliers, which can be seen in the lower-right corners of the plots in the first row
of Figure 2, affect the classical fits and lead to the underestimation of the serial dependence. We recall that the robust
method downweights the influence of these points when estimating a Gumbel copula. The robust estimates provide higher
parameter estimates, although sharing the copula family in the case of PETROBRAS. The robust fits reflect the pattern of
the majority of days and are expected to provide better long-run forecasts.
As requested by two reviewers, we provide in Table VII the results from the classical and robust D-vine fits to the
PETROBRAS series of realized log volatilities. As expected, the fits in tree 1 are the same (rounding to four decimal
places) because data are equal except for just one observation. As we will see shortly, the D-vine based out-of-sample
forecasts are clearly poorer than those provided by the C-vine fit.
As requested by one reviewer, we also provide in Table VI the C-vine fits for two other series of realized volatilities,
ITAU and VALE. In the case of ITAU, from Figure 2, we observe that there is a strong upper tail dependence in tree 1.
Although the plots indicate that the exchangeable Tawn copula could be a suitable candidate, the log-likelihood based
test statistically accepted the Gumbel fit. For the VALE-realized log volatility, the results are similar. Although one could
accept the equality of classical and robust copula parameters for some copulas in tree 1, the fits in the following trees were
based on different transformed data, resulting in changes in the copula families and forecasts.
To evaluate the pair-copula based one-step-ahead predictions, we simulate 1 million four-dimensional values from the
estimated model and approximate the conditional mean, given the recent past, by taking a window around the observed
lagged values and computing the mean of simulated predicted values. This procedure for approximating the mean value
based on simulations has already been used for the computation of financial measures, see for example, [50]. We retain the
estimated model during the entire out-of-sample period and incorporate each new daily observation as it comes, updating
the data. Twenty one-step-ahead realized log volatility predictions are obtained. We compare the performance of the pair-
copula based proposed robust forecasts with the classical ones, and for the sake of comprehensiveness, we also consider
the linear ARIMA .3; 0; 0/ predictions. On the basis of the visual inspection and distance measurements, we may say that
for all series analyzed, the pair-copula based proposed robust forecasts outperformed both competitors.
According to Andersen et al. [15], there is no general agreement on which loss function should be used when computing
and assessing the performance of out-of-sample competing forecasts. Likewise [15], we follow [14] and project the series
of log-realized volatilities onto a constant (ˇ0 ) plus the robust (ˇ1 ) and alternative (ˇ2 ) forecasts. The results are very
convincing, and we accept the null hypothesis that ˇ1 D 1 and reject the null hypothesis that ˇ2 D 1 for both alternative
methods.
In [15], regressing the realized log volatilities on each set of predictions and comparing the explained sum of squares are
also suggested. Again, the robust method outperformed the competitors, providing a R2 of 0.38, whereas the classical and
AR methods yielded the smaller numbers of 0.08 and 0.04, respectively. We note that regression estimates were obtained
on the basis of the least squares method and also of robust MM estimates, and both led to the same conclusion.
Finally, we compute the sum of the absolute differences among the three sets of predictions and the true-realized
volatilities. The robust method performed better for all series of RLVol. For example, in the case of PETROBRAS RLVol,
the robust procedure provided a value of 2.67, whereas the classical and the AR methodologies yielded the sums 3.94
195

and 3.12, respectively.

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
 B. VAZ DE MELO MENDES AND V. B. ACCIOLY

Log-Realized Volatility
0.0 0.2 0.4 0.6 0.8
5 10 15 20
Time
Log-Realized Volatility
0.0 0.2 0.4 0.6 0.8

5 10 15 20
Time

Figure 3. In the upper row, the PETROBRAS out-of-sample classical and robust canonical vine (C-vine) based volatility forecasts,
along with the AR(3) one-step-ahead predictions. In the lower row, the robust D-vine and C-vine predictions.

The upper row of Figure 3 shows the 20 one-step-ahead predictions under the classical and the robust C-vine estimation
methods, as well as their corresponding true-realized log volatilities. For all series of realized log volatilities, the pair-
copula based robust forecasts outperformed the linear AR predictions, a point also discussed in [15] and [44]. We do not
include the standard errors of predictions in Figure 3, because it is well known that very often, time series model-based out-
of-sample predictions (including the popular linear ARMA predictions) possess wide open confidence intervals. Actually,
the confidence intervals defined by plus/minus even one AR(3) standard error include all point estimates. Moreover, the
inclusion of the standard error makes the figures even more complicated, with too many lines for easy differentiation.
The lower row of Figure 3 shows the 20 one-step-ahead robust forecasts under the C-vine and the D-vine models. The
C-vine approach provided predictions closer (2.67) to the true-realized log volatilities. The sum of the absolute differences
between the true-realized volatilities and the robust D-vine predictions was 3.67, smaller than those based on the classi-
cal C-vine fit (3.94) but greater than those based on the linear model (3.12). As suggested by Reviewer 2, we provide,
in Figures A.1 and A.2 in the Appendix, the out-of-sample classical and robust C-vine predictions for the realized log
volatilities of ITAU and VALE.
It is interesting to note that for all stocks analyzed, the three fits in tree 1 were based on the Gumbel copula, which
possesses upper tail dependence (a sufficient condition for a vine model to possess multivariate tail dependence), and that
most of the conditional fits were based on an elliptical copula. Another common point was the skew-t as the underlying
distribution for all series of realized log volatility.
An interesting topic for future investigation could be the joint analysis of the serial dependence of a set of realized
volatilities (or any other set of time series) based on pair-copulas (suggested by one reviewer). This could lead to a
better understanding of the dynamic structures linking the series in an integrated financial world, where the dependences
among the volatilities of different risks could be assessed at different time points exposing contagion. To this end, one
would probably need an automated model selection and estimation technique, for example, the new ideas based on
graph theoretical considerations found in [51]. Actually, there has been a novel approach to model serial dependence
over different time series, see [52].

4. Discussion

Observing that the serial dependence in series of realized volatilities goes beyond the linear correlation, we proposed in this
paper modeling and forecasting the log volatility using robustly estimated pair-copula models. This method is appealing,
simple, and capable of handling the contaminations that may occur when working with huge high-frequency data. We
illustrate this idea in the context of emerging stock markets using most liquid Brazilian stocks. The proposed methodology
provided better volatility forecasts compared with those provided by linear models. In the future, these forecasts may be
196

used in many applications.

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
B. VAZ DE MELO MENDES AND V. B. ACCIOLY

Robust estimates for pair-copula models were obtained by extending the previous work of Mendes [1]. This extension
is straightforward because pair-copulas are simply hierarchical decompositions of a multivariate copula into a cascade of
bivariate copulas, and estimation takes place at the level of two-dimensional data. For each data configuration (contam-
inated or not), there is a a robust copula estimator that is at least as good as the MLE. Robust WMDE are proposed for
new copula families and the weighted version of the MLE proved again to be the best option for members of the elliptical
family of copulas. The favorable performance of robust estimators under C-vine models was assessed through simulations.
This methodology seems promising for time series forecasting, despite the type of observed serial dependence, linear
and nonlinear, short and long-range dependence, and potentially different (tail) dependence at consecutive small and
large values.
Future research will inspect whether the favorable forecast properties of robust pair-copula based volatility estimates
can be extended to the performance of risk measures. In addition, pair-copulas could be used to model the dynamics in the
second moment of a time series, as an alternative to ARCH models. Because of the current state of the integrated financial
world, another topic for further research is the joint analysis of the serial dependence of a set of realized log volatilities.

Appendix A

Figures A.1 and A.2 show, respectively, the out-of-sample classical and robust C-vine predictions for the realized log
volatilities of ITAU and VALE. In the case of ITAU (Figure A.1), the sum of the absolute deviations between the realized
and predicted log volatilities were 2.83, 3.25, and 3.08, respectively, for the robust C-vine, classical C-vine, and autore-
gressive methodologies. In the case of VALE (Figure A.2), these sums were 2.18, 4.44, and 3.20, respectively, which
amount to the best actual performances of robust estimates among all stocks analyzed.
1.0
Realized Log-Volatility of ITAU
0.8
0.6
0.4
0.2

5 10 15 20
Time

Figure A.1. The ITAU-realized log volatility and classical and robust C-vine based out-of-sample volatility forecasts, along with the
AR(3) one-step-ahead predictions.
Realized Log-Volatility of VALE
0.6
0.4
0.2
0.0

5 10 15 20
Time

The VALE-realized log volatility and classical and robust C-vine based out-of-sample volatility forecasts, along with the
197

Figure A.2.
AR(3) one-step-ahead predictions.

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
 B. VAZ DE MELO MENDES AND V. B. ACCIOLY

References
1. Mendes BVM, Melo EFL, Nelsen RB. Robust fits for copula models. Communication in Statistics 2007; 36:997–1017.
2. Joe H. Multivariate models and dependence concepts. Communications in Statistics, Simulation and Computation, ISSN 0361-0918 1997;
36(5):997–1017. DOI: 10.1080/03610910701539708.
3. Ibragimov R. Copula-based dependence characterizations and modeling for time series. Institute of Economic Research Working Papers 2094,
Harvard University, 2005.
4. Fantazzini D. Dynamic copula modelling for value at risk. Frontiers in Finance and Economics 2008; 5(2):72–108.
5. Beare BK. Copulas and temporal dependence. Econometrica 2010; 78(1):395–410.
6. Mendes BVM, Aíube C. Copula based models for serial dependence. International Journal of Managerial Finance 2011; 7(1):68 –82.
7. Darsow WF, Nguyen B, Olsen ET. Copulas and Markov processes. Illinois Journal of Mathematics 1992; 36(4):600–642.
8. la Peña VH, Ibragimov R, Sharakhmetov S. Characterizations of joint distributions, copulas, information, dependence and decoupling, with
applications to time series. Optimality: The Second Erich L. Lehmann Symposium Institute of Mathematical Statistics, Vol. 49, Lecture Notes
in Statistics. Institute of Mathematical Statistics, 2006; 183–209.
9. Ibragimov R. Copula-based characterizations for higher order Markov processes. Econometric Theory 2009; 25(03):819–846.
10. Chen X, Fan Y. Estimation of copula-based semiparametric time series models. Journal of Econometrics 2006; 130:307–335.
11. Chen X, Wu WB, Yi Y. Efficient estimation of copula-based semiparametric Markov models. Annals of Statistics 2009; 37(6B):4214–4253.
12. Domma F, Giordano S, Perri PF. Statistical modeling of temporal dependence in financial data via a copula function. Communications in
Statistics: Simulation and Computation 2009; 38(4):703–728.
13. Choroś B, Ibragimov R, Permiakova E. Copula estimation. Copula Theory and its Applications, Vol. 198, Jaworski P, Durante F, Härdle WK,
Rychlik T (eds), Lecture Notes in Statistics. Springer Berlin Heidelberg, 2010; 77–91.
14. Andersen TG, Bollerslev T. Answering the skeptics: yes, standard volatility models do provide accurate forecasts. International Economic
Review 1998; 39(4):885–905.
15. Andersen TG, Bollerslev T, Diebold FX, Labys P. Modeling and forecasting realized volatility. Econometrica 2003; 71(2):579–625.
16. Maheu JM, McCurdy TH. Nonlinear features of realized fx volatility. The Review of Economics and Statistics 2002; 84(4):668–681.
17. Sklar A. Fonctions de répartition à n dimensions et leurs marges. Technical Report 8, l’Institut de Statistique de L’Université de Paris, 1959.
18. Fang H-B, Fang K-T, Kotz S. The meta-elliptical distributions with given marginals. Journal of Multivariate Analysis 2002; 82:1–16.
19. Fang H, Fang K-T, Kotz S. Corrigendum to the meta-elliptical distribution with given marginal. Journal of Multivariate Analysis 2005;
94:222–223.
20. Bedford TJ, Cooke R. Probability density decomposition for conditionally dependent random variables modeled by vines. Annals of
Mathematics and Artificial Intelligence 2001; 32(1-4):245–268.
21. Bedford TJ, Cooke R. Vines—a new graphical model for dependent random variables. Annals of Statistics 2002; 30(4):1031–1068.
22. Kurowicka D, Cooke RM. Completion problem with partial correlation vines. Linear Algebra and its Applications 2006; 418(1):188–200.
23. Aas K, Czado C, Frigessi A, Bakken H. Pair-copula constructions of multiple dependence. Insurance: Mathematics and Economics 2009;
44(2):182–198.
24. Joe H, Xu JJ. The estimation method of inference functions for margins for multivariate models. Technical Report 166, Department of Statistics,
University of British Columbia, 1996.
25. Frahm G, Junker M, Schmidt R. Estimating the tail-dependence coeficient: properties and pitfalls. Mathematical Methods of Operations
Research 2004; 55(2):301–327.
26. Aas K, Berg D. Models for construction of multivariate dependence—a comparison study. European Journal of Finance 2009; 15(7–8):
639–659.
27. Czado C, Schepsmeier U, Min A. Maximum likelihood estimation of mixed c-vines with application to exchange rates. Statistical Modelling
2012; 3(12):229–255.
28. Dalla Valle L. Bayesian copulae distributions with application to operational risk management. Methodology and Computing in Applied
Probability 2009; 11:95–115.
29. Min A, Czado C. Bayesian inference for multivariate copulas using pair-copula constructions. Journal of Financial Econometrics 2010;
8(4):511–546.
30. Czado C. Pair-copula constructions of multivariate copulas. Workshop on Copula Theory and its Applications, Hrdle W, Jaworki P, Durante F,
Rychlik W (eds). Springer: Dordrecht, 2010.
31. Genest C, Ghoudi K, Rivest L. A semiparametric estimation procedure of dependence parameters in multivariate families of distributions.
Biometrika 1995; 82:543 –552.
32. Shih JH, Louis TA. Inferences on the association parameter in copula models for bivariate survival data. Biometrics 1995; 51(4):1384–1399.
33. Hampel FR, Ronchetti EM, Rousseeuw PJ, Stahel WA. Robust Statistics: The Approach based on Influence Functions. John Wiley & Sons,
2011, 528 pages.
34. Weiß G. Copula parameter estimation by maximum-likelihood and minimum-distance estimators: a simulation study. Computational Statistics
2011; 26(1):31–54.
35. Hering C. Estimation techniques and goodness-of-fit tests for certain copula classes in large dimensions. Dissertation, ULM University,
Stuttgart, February 2011.
36. Deheuvels P. La fonction de dépendance empirique et ses propriétés: Un test non paramétrique d’indépendence. Bulletin de la Classe de Scienc
5, Académie Royale de Belgique, 1979.
37. Deheuvels P. A kolmogorov-smirnov type test for independence and multivariate samples. Revue Roumaine de Mathématiques Pures et
Appliquées 1981; 26(2):213–226.
38. Deheuvels P. A non parametric test for independence. Technical Report 26, Publications de l’Institute de Statistique de l’Université de Paris,
1981.
39. Fermanian JD, Radulovic D, Wegkamp M. Weak convergence of empirical copula processes. Bernoulli 2004; 10(5):847–860.
198

40. Stahel WA. Robust estimation: infinitesimal optimality and covariance matrix estimators. Ph.D. Thesis, ETH, Zurich (in German), 1981.

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199
B. VAZ DE MELO MENDES AND V. B. ACCIOLY

41. Donoho DL. Breakdown properties of multivariate location estimators. Ph.D. Qualifying Paper, Department of Statistics, Harvard University,
1982.
42. Andersen TG, Bollerslev T, Diebold FX, Labys P. The distribution of realized exchange rate volatility. Journal of the American Statistical
Association 2001; 96:42–55.
43. Andersen TG, Bollerslev T, Cai J. Intraday and interday volatility in the japanese stock market. Journal of International Financial Markets,
Institutions and Money 2000; 10(2):107 –130.
44. Pong S, Shackleton MB, Taylor SJ, Xu X. Forecasting currency volatility: a comparison of implied volatilities and ar(fi)ma models. Journal of
Banking & Finance 2004; 28(10):2541–2563.
45. Andersen TG, Bollerslev T, Diebold FX, Ebens H. The distribution of realized stock return volatility. Journal of Financial Economics 2001;
61(1):43–76.
46. Andersen TG, Bollerslev T, Christoffersen PF, Diebold FX. Volatility and correlation forecasting. Handbook of Economic Forecasting, Vol. 1,
chapter 15, Elliott G, Granger CWJ, Timmermann A (eds). Elsevier, 2006; 777–878.
47. Hansen BE. Autoregressive conditional density estimation. International Economic Review 1994; 35(3):705–730.
48. Patton AJ. Modelling asymmetric exchange rate dependence. International Economic Review 2006; 47(2):527–556.
49. Genest C, Remillard B, Beaudoin D. Omnibus goodness-of-fit tests for copulas: a review and a power study. Insurance: Mathematics and
Economics 2009; 44:199 –213.
50. Hallerbach WGPM. Decomposing portfolio value-at-risk: a general. Discussion Papers 99-034/2, Tinbergen Institute, May 1999.
51. Dißmann J, Brechmann EC, Czado C, Kurowicka D. Selecting and estimating regular vine copulae and application to financial returns. preprint,
2013.
52. Brechmann EC, Czado C. Copar—multivariate time series modeling using the copula autoregressive model. preprint, 2012.

199

Copyright © 2013 John Wiley & Sons, Ltd. Appl. Stochastic Models Bus. Ind. 2014, 30 183–199