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Improving forecasting performance using covariate-dependent copula models

Feng Li () and Yanfei Kang

International Journal of Forecasting, 2018, vol. 34, issue 3, 456-476

Abstract: Copulas provide an attractive approach to the construction of multivariate distributions with flexible marginal distributions and different forms of dependences. Of particular importance in many areas is the possibility of forecasting the tail-dependences explicitly. Most of the available approaches are only able to estimate tail-dependences and correlations via nuisance parameters, and cannot be used for either interpretation or forecasting. We propose a general Bayesian approach for modeling and forecasting tail-dependences and correlations as explicit functions of covariates, with the aim of improving the copula forecasting performance. The proposed covariate-dependent copula model also allows for Bayesian variable selection from among the covariates of the marginal models, as well as the copula density. The copulas that we study include the Joe-Clayton copula, the Clayton copula, the Gumbel copula and the Student’s t-copula. Posterior inference is carried out using an efficient MCMC simulation method. Our approach is applied to both simulated data and the S&P 100 and S&P 600 stock indices. The forecasting performance of the proposed approach is compared with those of other modeling strategies based on log predictive scores. A value-at-risk evaluation is also performed for the model comparisons.

Keywords: Covariate-dependent copula; Financial forecasting; Tail-dependence; Kendall’s τ; MCMC (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1016/j.ijforecast.2018.01.007

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Handle: RePEc:eee:intfor:v:34:y:2018:i:3:p:456-476