Marginals versus copulas: Which account for more model risk in multivariate risk forecasting?

Simon Fritzsch, Maike Timphus and Gregor Weiß

Journal of Banking & Finance, 2024, vol. 158, issue C

Abstract: We study the model risk of multivariate risk models in a comprehensive empirical study on Copula-GARCH models used for forecasting Value-at-Risk and Expected Shortfall. To determine whether model risk inherent in the forecasting of portfolio risk is caused by the candidate marginal or copula models, we analyze different groups of models in which we fix either the marginals, the copula, or neither. Model risk is economically significant, especially high during periods of crisis, and almost completely due to the choice of the copula. We then propose the use of the model confidence set procedure to narrow down the set of available models and reduce model risk for Copula-GARCH risk models. Our proposed approach leads to a significant reduction of the model risk of one day ahead forecasts by our various candidate risk models.

Keywords: Portfolio risk; Model risk; Risk forecasting; Copulas (search for similar items in EconPapers)
JEL-codes: C53 C58 G17 G32 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:158:y:2024:i:c:s0378426623002261

DOI: 10.1016/j.jbankfin.2023.107035

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