Dependence structure between nominal and index-linked bond returns: a bivariate copula and DCC-GARCH approach

Abstract

This article investigates the dependence structure related to four French nominal and index-linked bonds with various maturities and reference indices. To achieve this aim, we estimate various copulas to select the appropriate one for our data. We also compare results obtained using the copula method with multivariate dynamic conditional correlation GARCH (DCC-GARCH) modelling. The major issue in this study is that the best copulas used to model the dependence among bond returns are the Plackett and Student models. We also find a dynamic correlation between bond returns. In particular, the relationship between nominal and indexed bonds is characterized by an asymmetric dependence. Moreover, the results obtained by the copula approach are confirmed by those obtained by multivariate GARCH modelling. Our empirical study provides a useful method that may be employed by decision-makers to quantitatively introduce dependence and spillover effects in their bond issuance policy. For investors, we propose optimal investment combinations in bonds with respect to their investment horizons.

Keywords:

• bond markets
• inflation
• dependence structure
• copula
• multivariate GARCH

JEL Classification:

• C13
• C22
• E44

Notes

¹ OATi : Obligations Assimilables du Trésor indexées. For more details one can consults the website: http://www.aft.gouv.fr/