Portfolio optimization based on forecasting models using vine copulas: An empirical assessment for the financial crisis

• Main Authors: Sahamkhadam, Maziar, Stephan, Andreas
• Format: Journal Article
• Language: English
• Published: 21.12.2019
• Subjects: Quantitative Finance - Portfolio Management
• DOI: 10.48550/arxiv.1912.10328

We employ and examine vine copulas in modeling symmetric and asymmetric dependency structures and forecasting financial returns. We analyze the asset allocations performed during the 2008-2009 financial crisis and test different portfolio strategies such as maximum Sharpe ratio, minimum variance, and minimum conditional Value-at-Risk. We then specify the regular, drawable, and canonical vine copulas, such as the Student-t, Clayton, Frank, Joe, Gumbel, and mixed copulas, and analyze both in-sample and out-of-sample portfolio performances. Out-of-sample portfolio back-testing shows that vine copulas reduce portfolio risk better than simple copulas. Our econometric analysis of the outcomes of the various models shows that in terms of reducing conditional Value-at-Risk, D-vines appear to be better than R- and C-vines. Overall, we find that the Student-t drawable vine copula models perform best with regard to risk reduction, both for the entire period 2005-2012 as well as during the financial crisis.