Dynamic Correlation or Tail Dependence Hedging for Portfolio Selection

Redouane Elkamhia and Denitsa Stefanova
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Redouane Elkamhia: University of Iowa, Henry B. Tippie College of Business

Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: We solve for the optimal portfolio allocation in a setting where both conditional correlation and theclustering of extreme events are considered. We demonstrate that there is a substantial welfare loss indisregarding tail dependence, even when dynamic conditional correlation has been accounted for, andvice versa. Both effects have distinct portfolio implications and cannot substitute each other. We alsoisolate the hedging demands due to macroeconomic and market conditions that command importanteconomic gains. Our results are robust to the sample period, the choice of the dependence structure,and both varying levels of average correlation and tail dependence coefficients.

Keywords: correlation hedging; dynamic portfolio allocation; Monte Carlo simulation; tail dependence (search for similar items in EconPapers)
JEL-codes: C15 C16 C51 G11 (search for similar items in EconPapers)
Date: 2011-02-11
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Citations: View citations in EconPapers (3)

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