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

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

Lorán Chollete (), Andréas Heinen () and Alfonso Valdesogo ()

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

Keywords: Asymmetric dependence; Canonical vine copula; International returns; Regime-Switching; Risk Management; Value-at-Risk; (follow links to similar papers)

JEL-Codes: C32; C35; G10; (follow links to similar papers)

43 pages, March 12, 2008

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