A copula-based simulation model for supply portfolio risk

ABSTRACT A copula-based simulation model for supply portfolio risk in the presence of dependent breaches of contracts is introduced in this paper. We demonstrate our method for a supply-chain contract portfolio of commodity metals traded at the London Metal Exchange (LME). The analysis of spot price data on six LME commodity metals leads us to use a t-copula dependence structure with t-marginals and generalized hyperbolic marginals for the log returns. We also provide efficient simulation algorithms using importance sampling for the normal and t - copula dependence structure to quantify risk measures, supply-at-risk and conditional supply-at-risk. Numerical examples on a portfolio of six commodity metals demonstrate that our proposed method succeeds in decreasing the variance of the simulations. A numerical sensitivity analysis for the choice of the copula function is also provided. To the best of our knowledge, this is the first paper proposing efficient simulation algorithms on a supply-chain contract portfolio that has a copula-based dependence structure with generalized hyperbolic marginals.