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Bayesian Inference for Latent Factor Copulas and Application to Financial Risk Forecasting

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  • Benedikt Schamberger

    (Department of Mathematics, Technical University of Munich, 85748 Garching, Germany
    These authors contributed equally to this work.)

  • Lutz F. Gruber

    (Department of Mathematics, Technical University of Munich, 85748 Garching, Germany
    These authors contributed equally to this work.)

  • Claudia Czado

    (Department of Mathematics, Technical University of Munich, 85748 Garching, Germany)

Abstract

Factor modeling is a popular strategy to induce sparsity in multivariate models as they scale to higher dimensions. We develop Bayesian inference for a recently proposed latent factor copula model, which utilizes a pair copula construction to couple the variables with the latent factor. We use adaptive rejection Metropolis sampling (ARMS) within Gibbs sampling for posterior simulation: Gibbs sampling enables application to Bayesian problems, while ARMS is an adaptive strategy that replaces traditional Metropolis-Hastings updates, which typically require careful tuning. Our simulation study shows favorable performance of our proposed approach both in terms of sampling efficiency and accuracy. We provide an extensive application example using historical data on European financial stocks that forecasts portfolio Value at Risk (VaR) and Expected Shortfall (ES).

Suggested Citation

  • Benedikt Schamberger & Lutz F. Gruber & Claudia Czado, 2017. "Bayesian Inference for Latent Factor Copulas and Application to Financial Risk Forecasting," Econometrics, MDPI, vol. 5(2), pages 1-23, May.
    • Handle: RePEc:gam:jecnmx:v:5:y:2017:i:2:p:21-:d:99406
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    References listed on IDEAS

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    2. Himchan Jeong & Dipak Dey, 2020. "Application of a Vine Copula for Multi-Line Insurance Reserving," Risks, MDPI, vol. 8(4), pages 1-23, October.
    3. Michael Stanley Smith, 2021. "Implicit Copulas: An Overview," Papers 2109.04718, arXiv.org.
    4. Kreuzer, Alexander & Czado, Claudia, 2021. "Bayesian inference for a single factor copula stochastic volatility model using Hamiltonian Monte Carlo," Econometrics and Statistics, Elsevier, vol. 19(C), pages 130-150.
    5. Nguyen, Hoang & Ausín, M. Concepción & Galeano, Pedro, 2020. "Variational inference for high dimensional structured factor copulas," Computational Statistics & Data Analysis, Elsevier, vol. 151(C).
    6. Zhong, Guang-Yan & Li, Jiang-Cheng & Jiang, George J. & Li, Hai-Feng & Tao, Hui-Ming, 2018. "The time delay restraining the herd behavior with Bayesian approach," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 507(C), pages 335-346.
    7. Smith, Michael Stanley, 2023. "Implicit Copulas: An Overview," Econometrics and Statistics, Elsevier, vol. 28(C), pages 81-104.
    8. Rezitis, Anthony N. & Rokopanos, Andreas & Tsionas, Mike G., 2021. "Investigating dynamic price co-movements in the international milk market using copulas: The role of trade agreements," Economic Modelling, Elsevier, vol. 95(C), pages 215-227.
    9. Verhoijsen Alex & Krupskiy Pavel, 2022. "Fast inference methods for high-dimensional factor copulas," Dependence Modeling, De Gruyter, vol. 10(1), pages 270-289, January.

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