A Semiparametric Approach to Value-at-Risk, Expected Shortfall and Optimum Asset Allocation in Stock-Bond Portfolios

This paper investigates stock-bond portfolios’tail risks such as value-at-risk (VaR) and expected shortfall (ES), and the way in which these measures have been a¤ected by the global …nancial crisis. The semiparametric t-copula is found to be adequate for modelling stock-bond joint distributions of G7 countries and Australia. Empirical results show that weak (negative) dependence has increased for seven countries after the crisis, while it has decreased for Italy. However, both VaR and ES have increased for all eight countries. Before the crisis, the minimum portfolio VaR and ES were achieved at an interior solution only for the US, the UK, Australia, Canada and Italy. After the crisis, the corner solution was found for all eight countries. Evidence of “‡ight to quality”and “safety …rst”investor behaviour was found to be strong, after the global …nancial crisis. The semiparametric t-copula adequately forecasts the outer-sample VaR. These …ndings have implications for global …nancial regulators and the Basel Committee, whose central focus is currently on increasing the capital requirements as a consequence of the recent global …nancial crisis. Keywords: Copula; Semiparametric method; Value-at-Risk; Investment decision JEL Classi…cations: C14, C52, G11, F36, G15 Corresponding author: Email [email protected]. Phone: +61 3990 32237. Postal address: 900, Dandenong Road, PO Box 197, Caul…eld East, Vic 3145, Australia.