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Value at Risk Trade-off and Capital Allocation With Copulas
Year Of Publication: 2001
Month Of Publication: July
Pages: 235-256
Download Count: 1896
View Count: 7852
Comment Num: 0
Language: EN
Source: working paper
Who Can Read: Free
Date: 9-1-2002
Publisher: Administrator
This paper uses copula functions in order to evaluate tail properties and and market risk trade-offs at a given confidence level without introducing the Normality assumption on returns. Copulas can be the appropriate tool to combine information in a non-Gaussian world and without restricting to the linear correlation coefficient since they are related to non-parametric measures of association. In addition they separate the marginal behavior from the association effect. We present an application to two stock market indices: for each market we recover the marginal probability distribution both parametrically and non. We then calibrate copula functions and recover the joint distribution. The estimated copulas give directly the tail probabilities, the joint probabilities of extreme losses occuring. Furthermore, their level curves measure the trade off at a given confidence level between losses over different desks. This trade off can be exploited for capital allocation. Fat tailedness of marginal returns is shown to have a strong effect on the trade off.
This document is published in Economic Notes (volume 30, number 2) July 2001, 235-256.
Cherubini, Umberto Sign in to follow this author
Luciano, Elisa Sign in to follow this author
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