EURO 2024 Copenhagen
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60. Sparse Vine copula-based portfolio optimization

Invited abstract in session MB-51: Market risk in a volatile world, stream Risk management in finance.

Monday, 10:30-12:00
Room: M5 (building: 101)

Authors (first author is the speaker)

1. Illia Kovalenko
Kemmy Business School, University of Limerick
2. Thomas Conlon
Michael Smurfit School of Business, University College Dublin
3. John Cotter
Michael Smurfit School of Business, University College Dublin

Abstract

This paper studies the use of the Regular Vine copula models in the context of the construction of portfolios with varying sizes. We find that copula-based portfolios outperform the naïve equally-weighted benchmark before transaction costs. Significantly reduced tail risk makes copula-based portfolios especially desirable for investors with high risk aversion. The superior performance is more pronounced during periods of high dependence asymmetry and high market volatility. Sparse vine models, in which independence pair-copulas prevail, provide significantly improved results for large portfolios across various performance measures, specifically reducing turnover. The improvement of portfolio performance, however, is attenuated as we take transaction costs into account. Limiting large portfolio turnover by increasing investment horizon or rebalancing error tolerance restores the outperformance of copula-based strategies.

Keywords

Status: accepted

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