Asymmetric Dependence in Finance: Diversification, Correlation and Portfolio Management in Market Downturns

The Guide to Avoiding Downturn Vulnerability by Managing Correlation Dependency

Solidly grounded in quantitative finance research, Asymmetric Dependence in Finance is the definitive resource that offers an important analysis of the risks and benefits of asset correlation. The book spans the topics managing asymmetric dependence using Copulas, to mitigating asymmetric dependence risk in real estate, credit and CTA markets that comprise a survey of the most current tools available for measuring and managing this crucial issue.

With contributions from noted experts in the field, this book explores the risks and benefits of asset correlation and offers the most current strategies and models that can be implemented to protect investments that are no longer insulated from downturns by simply diversifying funds. It clearly shows that the relation between assets is much richer than previously thought, and correlation between returns is dependent on the state of the market. Correlations between assets significantly increase during market downturns compared to market upturns. The benefits of diversification collapse at the very time fund managers need to rely on diversification.

To help investors avoid financial disasters such as the 2008 global financial crisis and the 2006 hedge–fund crisis, the authors outline practical measures that can be implemented to boost fund performance and a proven strategy for putting in place an options–based approach that limits a portfolio′s risk.

Written for fund managers, investors and financial officers, Asymmetric Dependence in Finance presents the most effective tools and strategies for improving fund, portfolio, and organization performance.

About the Editors ix

Introduction xi

CHAPTER 1 Disappointment Aversion, Asset Pricing and Measuring Asymmetric Dependence 1
Jamie Alcock and Anthony Hatherley

CHAPTER 2 The Size of the CTA Market and the Role of Asymmetric Dependence 17
Stephen Satchell and Oliver Williams

CHAPTER 3 The Price of Asymmetric Dependence 47
Jamie Alcock and Anthony Hatherley

CHAPTER 4 Misspecification in an Asymmetrically Dependent World: Implications for Volatility Forecasting 75
Salman Ahmed, Nandini Srivastava and Stephen Satchell

CHAPTER 5 Hedging Asymmetric Dependence 110
Anthony Hatherley

CHAPTER 6 Orthant Probability–Based Correlation 133
Mark Lundin and Stephen Satchell

CHAPTER 7 Risk Measures Based on Multivariate Skew Normal and Skew t –Mixture Models 152
Sharon X. Lee and Geoffrey J. McLachlan

CHAPTER 8 Estimating Asymmetric Dynamic Distributions in High Dimensions 169
Stanislav Anatolyev, Renat Khabibullin and Artem Prokhorov

CHAPTER 9 Asymmetric Dependence, Persistence and Firm–Level Stock Return Predictability 198
Jamie Alcock and Petra Andrlikova

CHAPTER 10 The Most Entropic Canonical Copula with an Application to Style Investment 221
Ba Chu and Stephen Satchell

CHAPTER 11 Canonical Vine Copulas in the Context of Modern Portfolio Management: Are They Worth It? 263
Rand Kwong Yew Low, Jamie Alcock, Robert Faff and Timothy Brailsford

Index 291

JAMIE ALCOCK, PHD, is Associate Professor of Finance at the University of Sydney Business School. He has previously held appointments at the University of Cambridge, Downing College Cambridge, and the University of Queensland. Dr. Alcock′s research interests include asset pricing, corporate finance, and real estate finance. The quality of his research has been recognized through multiple international research prizes, including most recently the EPRA Best Paper prize at the 2016 European Real Estate Society conference.

STEPHEN SATCHELL, PHD, PHD, is a Life Fellow at Trinity College Cambridge, a Professor of Finance at the University of Sydney and was an Honorary Visiting Professor at Birkbeck College, University of London. He is the Emeritus Reader in Financial Econometrics at the University of Cambridge and is an Honorary Member of the Institute of Actuaries. He specializes in finance and econometrics, on which he has written at least 200 papers.