Score-driven copula models for portfolios of two risky assets

ABSTRACT

The precise measurement of the association between asset returns is important for financial investors and risk managers. In this paper, we focus on a recent class of association models: Dynamic Conditional Score (DCS) copula models. Our contributions are the following: (i) We compare the statistical performance of several DCS copulas for several portfolios. We study the Clayton, rotated Clayton, Frank, Gaussian, Gumbel, rotated Gumbel, Plackett and Student's t copulas. We find that the DCS model with the Student's t copula is the most parsimonious model. (ii) We demonstrate that the copula score function discounts extreme observations. (iii) We jointly estimate the marginal distributions and the copula, by using the Maximum Likelihood method. We use DCS models for mean, volatility and association of asset returns. (iv) We estimate robust DCS copula models, for which the probability of a zero return observation is not necessarily zero. (v) We compare different patterns of association in different regions of the distribution for different DCS copulas, by using density contour plots and Monte Carlo (MC) experiments. (vi) We undertake a portfolio performance study with the estimation and backtesting of MC Value-at-Risk for the DCS model with the Student's t copula.

Keywords:

• Dynamic Conditional Score (DCS) models
• DCS copula models
• DCS models of location and scale

Jel classifications codes:

• C32
• C52
• C58

Acknowledgments

The authors are thankful for the helpful comments of the editor, the associate editor, the anonymous reviewer, Matthew Copley, Andrew Harvey and GESG seminar participants at Universidad Francisco Marroquín (June 17, 2016).

Disclosure statement

No potential conflict of interest was reported by the authors.

Additional information

Funding

Funding from the School of Business of Universidad Francisco Marroquín is gratefully acknowledged.