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Non-parametric estimation of copula parameters: testing for time-varying correlation

  • Jinguo Gong , Weiou Wu , David McMillan EMAIL logo and Daimin Shi
Published/Copyright: May 30, 2014

Abstract

The correlation structure of financial assets is a key input with regard to portfolio and risk management. In this paper, we propose a non-parametric estimation method for the time-varying copula parameter. This is achieved in two steps: first, displaying the marginal distributions of financial asset returns by applying the empirical distribution function; second, by implementing the local likelihood method to estimate the copula parameters. The method for obtaining the optimal bandwidth through a maximum pseudo likelihood function and a statistical test on whether the copula parameter is time-varying are also introduced. A simulation study is conducted to show that our method is superior to its contender. Finally, we verify the proposed estimation methodology and time-varying statistical test by analysing the dynamic linkages between the Shanghai, Shenzhen and Hong Kong stock markets.

JEL: C58; G12

Corresponding author: David McMillan, Accounting and Finance Division, Stirling Management School, University of Stirling, Stirling, UK, e-mail:

Acknowledgments

This project is supported by funding from Institution for New Economic Thinking’s Debt and Demography project; National Social Science Foundation of China (Grant No. 12CTJ007), National Natural Science Foundation of China (Grant No. 71171166) and Science Foundation of Ministry of Education of China (Grant No. 11XJC910001).

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Supplemental Material

The online version of this article (DOI: 10.1515/snde-2012-0089) offers supplementary material, available to authorized users.


Published Online: 2014-5-30
Published in Print: 2015-2-1

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