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The Methodology and Practice of EconometricsA Festschrift in Honour of David F. Hendry$
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Jennifer Castle and Neil Shephard

Print publication date: 2009

Print ISBN-13: 9780199237197

Published to Oxford Scholarship Online: September 2009

DOI: 10.1093/acprof:oso/9780199237197.001.0001

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Pitfalls in Modelling Dependence Structures: Explorations with Copulas *

Pitfalls in Modelling Dependence Structures: Explorations with Copulas *

(p.149) 6 Pitfalls in Modelling Dependence Structures: Explorations with Copulas*
The Methodology and Practice of Econometrics

Pravin K. Trivedi

David M. Zimmer

Oxford University Press

Tests of co-movements are often formulated as covariance or correlation restrictions in a multivariate (GARCH) framework. Although such a framework permits tests of hypotheses about contemporaneous co-movements such tests do not satisfactorily accommodate co-movements arising from more general models of dependence. This chapter proposes a model based on a finite mixture of copulas to test for co-movements. The mixture model is estimated using a two-step method in which the inference on marginals is separated from inference on the dependence parameter. The method is illustrated using Monte Carlo experiments and by analyzing co-movements in commodity prices using a number of copula mixture models. The analysis reveals the practical difficulties of identifying dependence parameters in a general nonlinear setting.

Keywords:   stochastic dependence, marginal distribution, copulas, finite mixture of copulas, excess co-movement hypothesis

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