What is copulas exactly, in probability and finance terms

In summary: The first line in the file is the name of the package, the package name starts with "copula". The first column is the name of the package, the second column is the version of the package and the third column is the author. So, in the above example, the first line is "copula/1.0", the second line is "copula/1.0.1" and the third line is "zlin034".
  • #1
colstat
56
0
Hi, all
I have been reading about copula, but still very confused.

What exactly is a copula? My understanding is: there are couple of components
1. uniform cdf marginal
2. a covariance matrix

What exactly is this thing? Why am I calculating the marginals and what does it have to do with the covariance matrix?

I am reading on the bivariate Gaussian copulas and t-copulas.
 
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  • #2
Copula is just a joint probability distribution. The beauty is that copula models correlation. The downside is it is difficult to formulate different couplas. I like baysian network modelling of joint distributions. Baysian network handles more variables, not only bivariates; the downside is discretization. If you are reading the most recent Significance magazine you will find out all copula can do to the financing industry.
 
  • #3
Thank you zlin034. What do you use to simulate copulas, Gaussian and student-t?

I have two ideas for bivariate Gaussian:
1. integrate the density from Wiki, here
http://en.wikipedia.org/wiki/Copula_(probability_theory)#Gaussian_copula

or this,
http://www.vosesoftware.com/ModelRi...n_ModelRisk/Copulas/Vose_Bivariate_Copula.htm

2. use Cholesky-decomposition [itex]\Sigma[/itex]=A'A,
then, generate iid standard normal random variables V = (V1, V2)',
then, get Xi from A*V, for i=1,2.
then, get ui= [itex]\Phi[/itex](Xi), for i=1,2.
 
  • #5
I am not using R, but even in R there's an algorithm right? Is there a way to see what they did in the package?
 
  • #6
R is open source right? Please read the source code from the package
 
  • #8
The compressed R packages have file extension .tar, they are called tar balls.

If you open the tar balls, you can see all sources codes are ASCII text files.
 

Related to What is copulas exactly, in probability and finance terms

1. What is a copula?

A copula is a mathematical function used to describe the relationship between two or more random variables. It allows for the modeling of complex correlation structures between variables and is commonly used in probability and finance to assess risk and make predictions.

2. How is a copula different from a correlation coefficient?

A correlation coefficient measures the strength and direction of the linear relationship between two variables, while a copula allows for the modeling of non-linear relationships. Additionally, a correlation coefficient only measures the relationship between two variables, while a copula can model the relationship between multiple variables simultaneously.

3. What is the importance of copulas in finance?

Copulas are important in finance because they allow for the modeling of complex dependencies between financial assets. This is crucial for accurately assessing risk and making predictions in the financial markets.

4. How are copulas used in risk management?

Copulas are commonly used in risk management to model the dependence between different financial assets. By understanding how these assets are correlated, risk managers can better assess the potential impact of market movements and make more informed decisions.

5. Are there different types of copulas?

Yes, there are several different types of copulas, including Gaussian, Archimedean, and Elliptical. Each type has its own properties and is used for different purposes depending on the specific application.

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