A Dynamic Grouped-T Copula Approach For High-Dimensional Portfolios

A Dynamic Grouped-T Copula Approach
for High-Dimensional Portfolios
Dean Fantazzini
April the 21th 2007,

International Workshop on Computational and Financial
Econometrics, Geneva (Switzerland)
Overview of the Presentation
1st Introduction
A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 2

1st Introduction
2nd Dynamic Grouped-T Copula Modelling: Definition and

Estimation
A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 2-a

1st Introduction

Estimation
3rd Asymptotic Properties
A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 2-b

1st Introduction

Estimation
4th A Simulation Study
A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 2-c

1st Introduction

Estimation
5th Empirical Analysis
A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 2-d

1st Introduction

Estimation
5th Empirical Analysis
6th Conclusions
A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 2-e

Introduction
The increasing complexity of financial markets has pointed out the need
for advanced dependence modelling in finance. Why?
• Multivariate models with more flexibility than the multivariate normal

distribution are needed;
• When constructing a model for risk management, the study of both

marginals and the dependence structure is crucial for the analysis. A
wrong choice may lead to severe underestimation of financial risks.
Recent developments in financial studies have tried to tackle these issues

by using the theory of Copulas: see Cherubini et al. (2004) for a general
review of copula methods in finance.
However, mostly low-dimensional applications have been considered so far,

while the rare high-dimensional cases present no dynamics at all.

Introduction
Daul, Giorgi, Lindskog, and McNeil (2003), Demarta and McNeil (2005)
and Mc-Neil, Frey, and Embrechts (2005) underlined the ability of the
grouped t-copula to model the dependence present in a large set of
financial assets into account.
We extend their methodology by allowing the copula dependence structure

to be time-varying and we show how to estimate its parameters.
Furthermore, we prove the consistency and asymptotic normality of this

estimator under some special cases and we examine its finite samples
properties via simulations.
Finally, we apply this methodology for the estimation of the VaR of a

portfolio composed of thirty assets.

Dynamic Grouped-T Copula Modelling: Definition and
Estimation
Let Z|Ft−1 ∼ Nn (0, Rt ), t = 1, . . . T , given the conditioning set Ft−1 ,

where Rt is the n × n conditional linear correlation matrix which follows a
DCC model, and R̄ is the unconditional correlation matrix. Furthermore
let U ∼ U nif orm(0, 1) be independent of Z .
p
Let Gν denote the distribution function of ν/χν , where χν is a chi
square distribution with ν degrees of freedom, and partition 1, . . . , n into
m subsets of sizes s1 , . . . , sm . Set Wk = G−1 νk (U ) for k = 1, . . . , m and then
Y|Ft−1 = (W1 Z1 , . . . , W1 Zs1 , W2 Zs1 +1 , . . . , W2 Zs1 +s2 , . . . , Wm Zn ), so
that Y has a so-called grouped t distribution. Finally, define
U|Ft−1 = (tν1 (Y1 ), . . . , tν1 (Ys1 ), tν2 (Ys1 +1 ), . . . , tν2 (Ys1 +s2 ), . . . , tνm (Yn ))
(1)
U has a distribution on [0, 1]n with components uniformly distributed on

[0, 1]. We call its distribution function the dynamic grouped t-copula.

Estimation
Note that (Y1 , . . . , Ys1 ) has a t distribution with ν1 degrees of freedom, and
in general for k = 1, . . . , m − 1, (Ys1 +...+sk +1 , . . . , Ys1 +...+sk+1 ) has a t
distribution with νk+1 degrees of freedom. Similarly, subvectors of U have
a t-copula with νk+1 degrees of freedom, for k = 0, . . . , m − 1.
In this case no elementary density has been given.
However, there is a very useful correlation approximation, obtained by

Daul et al. (2003) for the constant correlation case:
ρi,j (zi , zj ) ≈ sin(πτij (ui , uj )/2) (2)
where i and j belong to different groups and τij is the pairwise Kendall’s
tau. This approximation then allows for Maximum Likelihood estimation
for each subgroup separately.

Estimation
Definition 1 (Dynamic Grouped-T copula estimation).
1. Transform the standardized residuals (η̂1t , η̂2t , . . . , η̂nt ) obtained from a

univariate GARCH estimation, for example, into uniform variates
(û1t , û2t , . . . ûnt ), using either a parametric cumulative distribution
function (c.d.f.) or an empirical c.d.f..
2. Collect all pairwise estimates of the unconditional sample Kendall’s

tau given by
 −1
T
˜i,s )(ûj,t − û
˜j,s ) (3)
X
τ̄ˆi,j (ûj , ûk ) =   sign (ûi,t − û
2 1≤t<s<T
τ τ
ˆ ˆ
in an empirical Kendall’s tau matrix Σ̄ defined by Σ̄jk = τ̄ˆ(ûj , ûk ),
and then construct the unconditional correlation matrix using this
τ
ˆ π ˆ
relationship R̄j,k = sin( 2 Σ̄j,k ), where the estimated parameters are the
q = n · (n − 1)/2 unconditional correlations [ρ̄1 , . . . , ρ̄q ]′ .

Estimation
3. Look for the ML estimator of the degrees of freedom νk+1 by

maximizing the log-likelihood function of the T-copula density for each
subvector of U, for k = 0, . . . , m − 1:
T
ˆ , ν ),
X
ν̂1 = arg max log ct−copula (û1,t , . . . , ûs1 ,t ; R̄ 1 (4)
t=1
T
ˆ,ν
X
ν̂k+1 = arg max log ct−copula (ûs1 +...sk +1,t , . . . , ûs1 +...+sk+1 ,t ; R̄ k+1 ),
t=1
k = 1, . . . , m − 1 (5)

Estimation
4. Estimate a DCC(1,1) model for the conditional correlation matrix R̂t ,

by using QML estimation with the normal copula density:
T
ˆ,R ) =
X
α, β = arg max log cnormal (û1,t , . . . , ûn,t ; R̄ t (6)
t=1
T
X 1 1
= arg max 1/2
exp − ζ ′ (R−1
t − I)ζ (7)
t=1 |Rt | 2
where ζ = (Φ−1 (û1,t ), . . . , Φ−1 (ûn,t ))′ is the vector of univariate
normal inverse distribution functions, and where we assume the
following DCC(1,1) model for the correlation matrix R̂t
Rt = (diagQt )−1/2 Qt (diagQt )−1/2 (8)
L S
! L S
X X X X
Qt = 1− αl − βs Q̄ + αl ût−l û′t−l + βs Qt−s
l=1 s=1 l=1 s=1
where Q̄ is the n × n unconditional correlation matrix of ût , αl (≥ 0)

PL PS
and βs (≥ 0) are scalar parameters satisfying l=1 αl + s=1 βs < 1.

Asymptotic Properties
Let us define a moment function of the type
E [ψ (Fi (ηi ), Fj (ηj ); ρ̄i,j )] = E [ρ̄(zi , zj ) − sin(πτ (Fi (ηi ), Fj (ηj ))/2)] = 0 (9)
where the marginal c.d.f.s Fi , i = 1, . . . , n can be estimated either

parametrically or non-parametrically, we can easily define a q × 1 moments
vector ψ for the parameter vector θ0 = [ρ̄1 , . . . , ρ̄q ]′ as reported below:
 
E [ψ1 (F1 (η1 ), F2 (η2 ); ρ̄1 )]
..
 
ψ (F1 (η1 ), . . . , Fn (ηn ); θ0 ) =  =0
 
 . 
E [ψq (Fn−1 (ηn−1 ), Fn (ηn ); ρ̄q )]
(10)

Theorem 1.1.1 (Consistency of θ̂). Let assume that the standardized

errors (η1t , . . . , ηnt ) are i.i.d random variables with dependence structure
given by (1). Suppose that
(i) the parameter space Θ is a compact subset of Rq ,
(ii) the q-variate moment vector ψ (F1 (η1 ), . . . , Fn (ηn ); θ0 ) defined in (10)
is continuous in θ0 for all ηi ,
(iii) ψ (F1 (η1 ), . . . , Fn (ηn ); θ) is measurable in ηi for all θ in Θ,
(iv) E [ψ (F1 (η1 ), . . . , Fn (ηn ); θ)] 6= 0 for all θ 6= θ0 in Θ,
(v) E [supθ∈Θ kψ (F1 (η1 ), . . . , Fn (ηn ); θ) k] < ∞,
(vi) ρ̄i,j = 0 or ρ̄ij = o(1),

p
Then θ̂ → θ0 = [0]q×1 as n → ∞.

Theorem 1.1.2 (Consistency of ν̂k+1 , k = 0, . . . , m − 1). Let the

assumptions of the previous theorem hold, as well as the regularity
conditions reported in Proposition A.1 in Genest et al.(1995) with respect
to all the m t − copulas included in the grouped-t copula defined in (1).
p
Then ν̂k+1 → νk+1 as n → ∞.
Theorem 1.1.3 (Consistency of the DCC(1,1) parameters α̂ and

β̂). Let the assumptions of the previous theorem hold, as well as the
assumptions A1 - A5 in Engle and Sheppard (2001) with respect to the
p p
normal copula density (6). Then α̂ → 0 and β̂ → 0, as n → ∞.

The asymptotic normality is not straightforward, since we use a

multi-stage procedure where we perform a different kind of estimation at
every stage. A possible solution is to consider the ML used in the 3rd and
4th stages in Definition 1 as special method-of-moment estimators.
Let define the sample moments Ψ for the parameter vector

Ξ̂ = [ρ̄ˆ1 , . . . ρ̄ˆq , ν̂1 , . . . , ν̂m , α̂, β̂]′ as reported below:


Ψ F1 (η1,t ), . . . , Fn (ηn,t ); Ξ̂ =
 T 
1
ψ1 F1 (η1,t ), F2 (η2,t ); ρ̄ˆ1
P
T
t=1
 
 
 .. 
.
 
 

T

1
 
ˆ
P

 T
ψq Fn−1 (ηn−1,t ), Fn (ηn,t ); ρ̄q 

 t=1 
T
ˆ
 
1 P

 T
ψν1 F1 (η1,t ), . . . , Fs1 (ηs1,t ); R̄, ν̂1 

t=1
= =0
 
 .. 

 . 

 T 
 1 P ˆ
ψνm Fs1 +...+sm−1 +1 (ηs1 +...+sm−1 +1,t ), . . . , Fn (ηn,t ); R̄, ν̂m 

T


 t=1 

T

 1 P ˆ
ψα (F1 (η1,t ), . . . , Fn (ηn,t ); R̄, α̂, β̂)


 T 
 t=1 
T
ˆ
 
1 P
T
ψβ (F1 (η1,t ), . . . , Fn (ηn,t ); R̄, α̂, β̂)
t=1

Let also define the population moments vector with a correction to take
the non-parametric estimation of the marginals into account, together with
its variance (see Genest et al. (1995), § 4):
 
ψ1 (F1 (η1 ), F2 (η2 ); ρ̄1 )
.
 
..
 
 
 
 

 ψq (Fn−1 (ηn−1 ), Fn (ηn ); ρ̄q ) 

 s
P 1 
ψν1 F1 (η1 ), . . . , Fs1 (ηs1 ); R̄, ν1 + Wi,ν1 (ηi )
 
 
 i=1 
..
 
∆0 =  

 . 

 Pn 
ψνm Fs1 +...+sm−1 +1 (η1 ), . . . , Fn (ηn ); R̄, νm + Wi,νm (ηi ) 
 

 i=s1 +...+sm−1 +1 
n
 
 P 

 ψα (F1 (η1 ), . . . , Fn (ηn ); R̄, α, β) + Wi,α (ηi ) 

i=1
n
 
 P 
ψβ (F1 (η1 ), . . . , Fn (ηn ); R̄, α, β) + Wi,β (ηi )
i=1
(11)
′

Υ0 ≡ var [∆0 ] = E ∆0 ∆0 (12)

where
∂2
Z
Wi,ν1 (ηi ) = 1l Fi (ηi )≤ui log c(u1 , . . . us1 ; R̄, ν1 )dC(u1 , . . . , us1 )
∂ν1 ∂ui
..
. (13)
∂2
Z
Wi,νm (ηi ) = 1l Fi (ηi )≤ui log c(ui=s1 +...+sm−1 +1 , . . . un ; R̄, νm )
∂νm ∂ui
dC(ui=s1 +...+sm−1 +1 , . . . , un )
(14)
∂2
Z
Wi,α (ηi ) = 1l Fi (ηi )≤ui log c(u1 , . . . un ; R̄, α, β)dC(u1 , . . . , un )
∂α∂ui
∂2
Z
Wi,β (ηi ) = 1l Fi (ηi )≤ui log c(u1 , . . . un ; R̄, α, β)dC(u1 , . . . , un )
∂β∂ui
(15)

Theorem 1.1.4 (Asymptotic Distribution). Consider the general case

where the marginals are estimated non-parametrically by using the
empirical distributions functions. Let the assumptions of the previous
theorems hold. Assume further that ∂Ψ(·;Ξ)
∂Ξ′
is O(1) and uniformly negative
definite, while Υ0 is O(1) and uniformly positive definite. Then, the
multi-stages estimator of the dynamic grouped-t copula verifies the
properties of asymptotic normality:
√ d
∂Ψ −1 ∂Ψ −1′
T (Ξ̂ − Ξ0 ) −→ N 0, E ∂Ξ′ Υ0 E ∂Ξ′ (16)

Simulation Study
The previous asymptotic properties hold only under the very special case
when zi , zj are uncorrelated and R is the identity matrix. When this
restriction does not hold, the estimation procedure previously described
may not deliver consistent estimates.
Daul et al. (2003) performed a Monte-Carlo study with a grouped-t copula

with constant R, employing an estimation procedure equal to the first
three steps of definition 1.
They showed that the correlations parameters present a bias that increases
nonlinearly in Rj,k , but the magnitude of the error is rather low. Instead,
no evidence is reported for the degrees of freedom.

Simulation Study
We consider the following possible DGPs:
1. We examine the case that four variables have a Grouped-T copula

with m = 2 groups, with unconditional correlation matrix R̄ of the
underlying multivariate normal random vector Z equal to
1 0.30 -0.20 0.50
0.30 1 -0.25 0.40
-0.20 -0.25 1 0.10
0.50 0.40 0.10 1
2. We examine different values for the DCC(1,1) model parameters,

equal to [α = 0.10, β = 0.60] and [α = 0.01, β = 0.95]. The former
corresponds to a case of low persistence in the correlations, while the
latter implies strong persistence in the correlation structure, instead.

Simulation Study
3. We examine two cases for the degrees of freedom νk for the m = 2

groups:
• ν1 = 3 and ν2 = 4;
• ν1 = 6 and ν2 = 15;
The first case corresponds to a situation of strong tail dependence, that
is there is a high probability to observe an extremely large observation
on one variable, given that the other variable has yielded an extremely
large observation. The last exhibit low tail dependence, instead.
4. We consider three possible data situations: n = 500, n = 1000 and

n = 10000.

Simulation Study
• Unconditional correlation parameters R̄j,k : there is a general negative

bias that stabilize after n = 1000. However, this bias is quite high
when there is strong tail dependence among variables (νk are low),
while it is much lower when the tail dependence is rather weak (νk are
high). Besides, it almost disappears when correlations are lower than
0.10, thus confirming the previous asymptotics results. The effects of
different dynamic structure in the correlations are negligible, instead.
• DCC(1,1) parameters (α, β): the higher is the persistence in the

correlations structure (high β), the quicker β̂ converges to the true
values. In general, the effects of different DGPs on β are almost
negligible. The parameter α describing the effect of past shocks shows
positive biases, instead, that are higher in magnitude when high tail
dependence and high persistence in the correlations are considered.

Simulation Study
• Degrees of freedom νk : the speed of convergence towards the true

values is, in general, very low and changes substantially according to
the magnitude of νk and the dynamic structure in the correlations.
Particularly, when there is high tail dependence (νk are low) the
convergence is much quicker than when there is low tail dependence
(νk are high). Furthermore, the convergence is quicker when there is
strong persistence in the correlations structure (β is high), rather than
the persistence is weak (β is low).
This is good news since financial assets usually show high tail
dependence and high persistence in the correlations (see Mcneil et al.
(2005) and references therein). Besides, it is interesting to note that
the biases are negative for all the considered DGPs, i.e. the estimated
ν̂k are lower than the true values νk .

Simulation Study
We explore the consequences of our multi-step estimation procedure of the

dynamic grouped-t copula on Value at Risk (VaR) estimation, by using
the same DGPs previously discussed.
As we want to study only the effects of the estimated dependence

structure, we consider the same marginals for all DGPs, as well as the
same past shocks ût−1 . For sake of simplicity, we suppose to invest an
amount Mi = 1$, i = 1, . . . , n = 4 in every asset.
We consider eight different quantiles to better highlight the overall effects

of the estimated copula parameters on the joint distribution of the losses:
0.25%, 0.50%, 1.00%, 5.00%, 95.00%, 99.00%, 99.50%, 99.75%.

Simulation Study
In general, the estimated quantiles show a very small underestimation,

which can range between 0 and 3%. Particularly, we can observe that
• the error in the approximation of the quantiles is lower the lower the
tail dependence between assets is, i.e. when νk are high, ceteris
paribus. As a consequence, when estimating the quantile they tend to
offset the effect of lower correlations, which would decrease the
computed quantile, instead.
• the error in the approximation of the quantiles is lower the higher is

the persistence in the correlations, ceteris paribus. This result is due to
the much smaller biases of the parameters α, β when the true DGPs
are characterized by high persistence in the correlations.

Simulation Study
• the error in the approximation of the quantiles tend to slightly increase

as long as the sample dimension increases. Such a result can be
explained considering that the computed degrees of freedom ν̂k slowly
converge to the true values when the dimension of the dataset
increases, while the negative biases in the correlations tend to
stabilize. As a consequence, the computed ν̂k do not offset any more
the effect of lower correlations, and therefore the underestimation in
the VaR increases.
• the approximations of the extreme quantiles are much better than those
of the central quantiles, while the analysis reveals no major difference
between left tail and right tail.
• It is interesting to note that up to medium-sized datasets consisting of

n = 1000 observations, the effects of the biases in the degrees of
freedom and the biases in the correlations tend to offset each other and
the error in approximating the quantile is close to zero.

Empirical Analysis
In order to compare our approach with previous multivariate models

proposed in the literature, we measured the Value at Risk of a
high-dimensional portfolio composed of 30 assets .
Marginal Moment Copula Copula Parameters
Distribution specification Specification
Model 1) NORMAL AR(1) NORMAL Constant Correlation
T-GARCH(1,1)
Model 2) NORMAL AR(1) NORMAL DCC(1,1)
T-GARCH(1,1)
Model 3) SKEW-T AR(1) T-COPULA Constant Correlation
T-GARCH(1,1) Const. D.o.F.
Model 4) SKEW-T AR(1) T-COPULA DCC(1,1)
T-GARCH(1,1) Constant D.o.F.
Model 5) SKEW-T AR(1) GROUPED T Constant Correlation
T-GARCH(1,1) Constant D.o.F.s
Model 6) SKEW-T AR(1) GROUPED T DCC(1,1)
T-GARCH(1,1) Constant D.o.F.s
As for the grouped-t copula, we classify the assets in 5 groups according to

their credit rating: 1) AAA; 2) AA (AA+,AA,AA−); 3) A (A+,A,A−); 4)
BBB (BBB+,BBB,BBB−); 5) BB (BB+,BB,BB−).

Empirical Analysis
We will assess the performance of the competing multivariate models using

the following back-testing techniques
• Kupiec (1995) unconditional coverage test;
• Christoffersen (1998) conditional coverage test;
• Loss functions to evaluate VaR forecast accuracy;
• Hansen and Lunde (2005) and Hansen’s (2005) Superior Predictive

Ability (SPA) test.

Empirical Analysis
1. Kupiec’s test: Following binomial theory, the probability of

observing N failures out of T observations is (1-p)T −N pN , so that the
test of the null hypothesis H0 : p = p∗ is given by a LR test statistic:
N
LR = 2 · ln[(1 − p∗ )T −N p∗ ] + 2 · ln[(1 − N/T )T −N (N/T )N ]
2. Christoffersen’s test: . Its main advantage over the previous

statistic is that it takes account of any conditionality in our forecast:
for example, if volatilities are low in some period and high in others,
the VaR forecast should respond to this clustering event.
LRCC = −2 ln[(1−p)T −N pN ]+2 ln[(1 −π01 )n00 π01

n01
(1−π11 )n10 π11
n11
]
where nij is the number of observations with value i followed by j for

i, j = 0, 1 and
nij
πij = P
j nij

Empirical Analysis
3. Loss functions: As noted by the Basle Committee on Banking

Supervision (1996), the magnitude as well as the number of exceptions
are a matter of regulatory concern. Since the object of interest is the
conditional α-quantile of the portfolio loss distribution, we use the
asymmetric linear loss function proposed in Gonzalez and Rivera
(2006) and Giacomini and and Komunjer (2005), and defined as
Tα (et+1 ) ≡ (α − 1l (et+1 < 0))et+1 (17)
where et+1 = Lt+1 − V aR\ t+1|t , Lt+1 is the realized loss, while
\
V aR t+1|t is the VaR forecast at time t + 1 on information available at
time t.
4. Hansen’s (2005) Superior Predictive Ability (SPA) test: The
SPA test is a test that can be used for comparing the performances of
two or more forecasting models.
The forecasts are evaluated using a prespecified loss function and the
“best” forecast model is the model that produces the smallest loss.

Empirical Analysis
Long position Short position

0.25% 0.50% 1% 5% 0.25% 0.50% 1% 5%
Model 1) 5.275 8.963 14.512 47.131 5.722 8.855 13.987 44.517
Model 2) 4.843 8.281 13.967 45.584 7.598 11.006 16.521 47.243
Model 3) 3.610 7.603 13.929 46.574 4.777 8.118 13.508 44.314
Model 4) 4.462 8.354 14.381 46.386 4.974 8.265 13.644 44.138
Model 5) 3.880 7.942 14.304 47.101 4.870 8.082 13.797 44.432
Model 6) 3.374 7.143 13.448 45.553 4.901 8.447 13.661 44.329
Table 1: Asymmetric loss functions (17). The smallest value is re-

ported in bold font.

Empirical Analysis
Long position Short Position

Benchmark 0.25% 0.50% 1% 5% 0.25% 0.50% 1% 5%
Model 1) 0.012 0.003 0.013 0.115 0.113 0.133 0.113 0.113
Model 2) 0.009 0.015 0.132 0.780 0.299 0.300 0.279 0.248
Model 3) 0.380 0.165 0.093 0.005 0.999 0.951 0.999 0.994
Model 4) 0.239 0.221 0.239 0.171 0.276 0.300 0.297 0.591
Model 5) 0.096 0.091 0.093 0.016 0.875 0.990 0.735 0.866
Model 6) 0.979 0.970 0.967 0.917 0.832 0.155 0.800 0.959
Table 2: Hansen’s SPA test for the portfolio consisting of thirty

stocks. P-values smaller than 0.10 are reported in bold font.

Empirical Analysis
Long positions
0.25% 0.50% 1% 5%
M. N/T pU C pCC N/T pU C pCC N/T pU C pCC N/T pU C pCC
1) 1.40% 0.00 0.00 1.90% 0.00 0.00 2.30% 0.00 0.00 6.30% 0.07 0.19
2) 1.30% 0.00 0.00 1.60% 0.00 0.00 1.90% 0.01 0.03 5.80% 0.26 0.49
3) 0.90% 0.00 0.01 1.40% 0.00 0.00 2.00% 0.01 0.01 6.60% 0.03 0.08
4) 0.60% 0.06 0.17 1.40% 0.00 0.00 1.90% 0.01 0.03 6.20% 0.09 0.24
5) 0.80% 0.01 0.02 1.30% 0.00 0.00 1.90% 0.01 0.03 6.10% 0.12 0.18
6) 0.50% 0.16 0.37 1.10% 0.02 0.02 1.80% 0.02 0.05 6.00% 0.16 0.35
Table 3: Actual VaR exceedances N/T , Kupiec’s and Christoffersen’s

tests for the portfolio consisting of thirty stocks (Long positions).

Empirical Analysis
Short positions
0.25% 0.50% 1% 5%
M. N/T pU C pCC N/T pU C pCC N/T pU C pCC N/T pU C pCC
1) 0.80% 0.01 0.02 1.00% 0.05 0.06 1.50% 0.14 0.16 5.30% 0.67 0.71
2) 0.70% 0.02 0.06 0.90% 0.11 0.06 1.30% 0.36 0.56 5.00% 1.00 0.95
3) 0.20% 0.74 0.94 0.70% 0.40 0.07 0.90% 0.75 0.87 5.90% 0.20 0.43
4) 0.30% 0.76 0.95 0.70% 0.40 0.06 0.90% 0.75 0.87 5.50% 0.47 0.77
5) 0.30% 0.76 0.95 0.80% 0.22 0.06 0.90% 0.75 0.87 4.80% 0.77 0.54
6) 0.30% 0.76 0.95 0.70% 0.40 0.35 0.90% 0.75 0.87 5.20% 0.77 0.94
Table 4: Actual VaR exceedances N/T , Kupiec’s and Christoffersen’s

tests for the portfolio consisting of thirty stocks (Short positions).

Conclusions
• Introduction of the dynamic grouped-t copula for the joint

modelling of high-dimensional portfolios, where we use the DCC
model to specify the time evolution of the correlation matrix of
the grouped-t copula.
• Consistency and asymptotic normality of the estimator under the
special case of a correlation matrix equal to the identity matrix.
• Monte Carlo simulations to study the properties of this estimator
under different data generating processes where such a strong
restriction on the correlation matrix does not hold.
• We investigated the effects of such biases and finite sample
properties on conditional quantile estimation, given the
increasing importance of the Value-at-Risk as risk measure. We
found that the error in the approximation of the quantile can
range between 0 and 3%.

Conclusions
• Empirical analysis 1: When long positions were of concern, we

found that the dynamic grouped-T copula (together with
skewed-t marginals) outperformed both the constant grouped-t
copula and the dynamic student’s T copula as well as the
dynamic multivariate normal model proposed in Engle (2002).
• Empirical analysis 2: As for short positions, we found out that a
multivariate normal model with dynamic normal marginals and
constant normal copula was already a proper choice. This last
result confirms previous evidence in Junker and May (2005) and
Fantazzini (2008) for bivariate portfolios.
• Avenue for future research 1: more sophisticated methods to
separate the assets into homogenous groups when using the
grouped-t copula.
• Avenue for future research 2: look for alternatives to DCC
modelling
References
References
[1] Basle Committee on Banking Supervision (1996). Supervisory
Framework for the Use of Backtesting in Conjunction with the Internal
Models Approach to Market Risk Capital Requirements, Basel, January.
[2] Basle Committee on Banking Supervision (2005). Amendment to the
Capital Accord to Incorporate Market Risks, BIS.
[3] Cherubini, U. and Luciano, E. and W. Vecchiato W. (2004). Copula
Methods in Finance, Wiley.
[4] Christoffersen, P. (1998). Evaluating Interval Forecats, International
Economic Review, 39, 841-862.
[5] Daul, S. and De Giorgi, E. and Lindskog, F. and McNeil, A. (2003).
The grouped t-copula with an application to credit risk, Risk,1, 73–76.
[6] Demarta, S. and McNeil, A. J. (2005). The t Copula and Related
Copulas, International Statistical Review, 73, 111 –129.
[7] Fantazzini, D. (2008). Dynamic Copula Modelling for Value at Risk,
Frontiers in Finance and Economics, 5(2), 72-108.
[8] Fantazzini, D. (2009a). A Dynamic Grouped-T Copula Approach for

References
Market Risk Management, (in) The Var Implementation Handbook, p.

253-282, McGraw-Hill, New York
[9] Genest, C. and Ghoudi, K. and Rivest, L. (1995). A semiparametric
estimation procedure of dependence parameters in multivariate families of
distributions, Biometrika, 82, 543 - 552.
[10] Giacomini, R. and Komunjer, I. (2005). Evaluation and Combination of
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Statistics, 23, 416-431.
[11] González-Rivera, G. and Lee, T. and Santosh, M. (2006). Forecasting
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Management: Concepts, Techniques and Tools, Princeton University Press.

A Dynamic Grouped-T Copula Approach For High-Dimensional Portfolios

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A Dynamic Grouped-T Copula Approach

for High-Dimensional Portfolios

April the 21th 2007,

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 2

2nd Dynamic Grouped-T Copula Modelling: Definition and

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 2-a

2nd Dynamic Grouped-T Copula Modelling: Definition and

3rd Asymptotic Properties

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 2-b

2nd Dynamic Grouped-T Copula Modelling: Definition and

3rd Asymptotic Properties

4th A Simulation Study

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 2-c

2nd Dynamic Grouped-T Copula Modelling: Definition and

3rd Asymptotic Properties

4th A Simulation Study

5th Empirical Analysis

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 2-d

2nd Dynamic Grouped-T Copula Modelling: Definition and

3rd Asymptotic Properties

4th A Simulation Study

5th Empirical Analysis

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 2-e

• Multivariate models with more flexibility than the multivariate normal

• When constructing a model for risk management, the study of both

Recent developments in financial studies have tried to tackle these issues

However, mostly low-dimensional applications have been considered so far,

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 3

We extend their methodology by allowing the copula dependence structure

Furthermore, we prove the consistency and asymptotic normality of this

Finally, we apply this methodology for the estimation of the VaR of a

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 4

Let Z|Ft−1 ∼ Nn (0, Rt ), t = 1, . . . T , given the conditioning set Ft−1 ,

U has a distribution on [0, 1]n with components uniformly distributed on

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 5

In this case no elementary density has been given.

However, there is a very useful correlation approximation, obtained by

ρi,j (zi , zj ) ≈ sin(πτij (ui , uj )/2) (2)

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 6

Definition 1 (Dynamic Grouped-T copula estimation).

1. Transform the standardized residuals (η̂1t , η̂2t , . . . , η̂nt ) obtained from a

2. Collect all pairwise estimates of the unconditional sample Kendall’s

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 7

3. Look for the ML estimator of the degrees of freedom νk+1 by

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 8

4. Estimate a DCC(1,1) model for the conditional correlation matrix R̂t ,

where Q̄ is the n × n unconditional correlation matrix of ût , αl (≥ 0)

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 9

Let us define a moment function of the type

where the marginal c.d.f.s Fi , i = 1, . . . , n can be estimated either

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 10

Theorem 1.1.1 (Consistency of θ̂). Let assume that the standardized

(i) the parameter space Θ is a compact subset of Rq ,

(iii) ψ (F1 (η1 ), . . . , Fn (ηn ); θ) is measurable in ηi for all θ in Θ,

(iv) E [ψ (F1 (η1 ), . . . , Fn (ηn ); θ)] 6= 0 for all θ 6= θ0 in Θ,

(v) E [supθ∈Θ kψ (F1 (η1 ), . . . , Fn (ηn ); θ) k] < ∞,

(vi) ρ̄i,j = 0 or ρ̄ij = o(1),

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 11

Theorem 1.1.2 (Consistency of ν̂k+1 , k = 0, . . . , m − 1). Let the

Theorem 1.1.3 (Consistency of the DCC(1,1) parameters α̂ and

A Dynamic Grouped-T Copula Approach for High-Dimensional Portfolios 12

The asymptotic normality is not straightforward, since we use a

Let define the sample moments Ψ for the parameter vector