introduction copula.pdf

ST 810-006 Statistics and Financial Risk Copulas A copula is the joint distribution of random variables U1,U2, . . . ,Up, each of which is marginally uniformly distributed as U(0, 1). The term copula is also used for the joint cumulative distribution function of such a distribution, C (u1, u2, . . . , up) = P (U1 ≤ u1,U2 ≤ u2, . . . ,Up ≤ up) . 1 / 39 ST 810-006 Statistics and Financial Risk Examples If U1,U2, . . . ,Up are independent, C (u1, u2, . . . , up) = u1 × u2 × · · · × up. If they are completely dependent (U1 = U2 = · · · = Up with probability 1), C (u1, u2, . . . , up) = min (u1, u2, . . . , up) 2 / 39 ST 810-006 Statistics and Financial Risk Sklar’s Theorem Copulas are important because of Sklar’s Theorem: For any random variables X1,X2, . . . ,Xp with joint c.d.f. F (x1, x2, . . . , xp) = P (X1 ≤ x1,X2 ≤ x2, . . . ,Xp ≤ xp) and marginal c.d.f.s Fj(x) = P (Xj ≤ x) , j = 1, 2, . . . , p, there exists a copula such that F (x1, x2, . . . , xp) = C [F1 (x1) ,F2 (x2) , . . . ,Fp (xp)] . If each Fj(x) is continuous, C is unique. 3 / 39 ST 810-006 Statistics and Financial Risk That is, we can describe the joint distribution of X1,X2, . . . ,Xp by the marginal distributions Fj(x) and the copula C . The copula (Latin: link) links the marginal distributions together to form the joint distribution. From a modeling perspective, Sklar’s Theorem allows us to separate the modeling of the marginal distributions Fj(x) from the dependence structure, which is expressed in C . 4 / 39 ST 810-006 Statistics and Financial Risk The proof is simple in the case that all Fj(x) are continuous, because in this case each has an inverse function F?1j (·) such that Fj [ F?1j (u) ] = u, for all 0 ≤ u ≤ 1. If Uj = Fj (Xj), then Uj ～ U(0, 1): P (Uj ≤ u) = P [Fj (Xj) ≤ u] = P [ Xj ≤ F?1j (u) ] = Fj [ F?1j (u) ] = u. Write C for the c.d.f. of this copula; then F (x1, x2, . . . , xp) = P (X1 ≤ x1,X2 ≤ x2, . . . ,Xp ≤ xp) = P [U1 ≤ F1 (x1) ,U2 ≤ F2 (x2) , . . . ,Up ≤ Fp (xp)] = C [F1 (x1) ,F2