Value-at-Risk Trade-Off and Capital Allocation with Copulas

Posted: 8 Jun 2001

See all articles by Elisa Luciano

Elisa Luciano

University of Turin - Department of Statistics and Applied Mathematics

Umberto Cherubini

University of Bologna - Department of Economics

Abstract

This paper uses copula functions in order to evaluate tail probabilities and market risk trade-offs at a given confidence level, dropping the joint normality assumption on returns. Copulas enable to represent distribution functions separating the marginal distributions from the association structure. We present an application to two stock market indices: for each market we recover the marginal probability distribution. We then calibrate copula functions and recover the joint distribution. The estimated copulas directly give the joint probabilities of extreme losses. Their level curves measure the trade-off between losses over different desks. This trade off can be exploited for capital allocation and is shown to depend on fat-tails.

JEL Classification: G19, G29, C14

Suggested Citation

Luciano, Elisa and Cherubini, Umberto, Value-at-Risk Trade-Off and Capital Allocation with Copulas. Available at SSRN: https://ssrn.com/abstract=268736

Elisa Luciano

University of Turin - Department of Statistics and Applied Mathematics ( email )

Corso Unione Sovietica 218 bis
Turin, I-10122
Italy
+ 39 011 6705230 (Phone)

Umberto Cherubini (Contact Author)

University of Bologna - Department of Economics ( email )

Strada Maggore, 45
Bologna, FI 40125
Italy
+ +39 051 2092615 (Phone)

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