Portfolio optimization in the presence of dependent financial returns with long memory: A copula based approach

Heni Boubaker () and Nadia Sghaier ()

Journal of Banking & Finance, 2013, vol. 37, issue 2, 361-377

Abstract: In this paper, we seek to examine the effect of the presence of long memory on the dependence structure between financial returns and on portfolio optimization. First, we focus on the dependence structure using copulas. To select the best copula, in addition to the goodness of fit tests, we employ a graphical method based on visual comparison of the fitted copula density and the smoothed copula density estimated by wavelets. Moreover, we check the stability of the copula parameter. The empirical results show that the long memory affects the dependence structure. Second, we analyze the impact of this dependence structure on the optimal portfolio. We propose a new approach based on minimizing the Conditional Value at Risk and assuming that the dependence structure is modeled by the copula parameter. The empirical results show that our approach outperforms the traditional minimizing variance approach, where the dependence structure is represented by the linear correlation coefficient.

Keywords: Long memory; Portfolio optimization; Copulas; Goodness of fit tests; Wavelets; Stability tests; Conditional value at risk (search for similar items in EconPapers)
JEL-codes: C14 C32 G11 G15 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (64)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:37:y:2013:i:2:p:361-377

DOI: 10.1016/j.jbankfin.2012.09.006

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