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Econometric Reviews
ISSN: 0747-4938 (Print) 1532-4168 (Online) Journal homepage: http://www.tandfonline.com/loi/lecr20
A multivariate volatility vine copula model

E. C. Brechmann, M. Heiden & Y. Okhrin
To cite this article: E. C. Brechmann, M. Heiden & Y. Okhrin (2015): A multivariate volatility vine
copula model, Econometric Reviews, DOI: 10.1080/07474938.2015.1096695
To link to this article: http://dx.doi.org/10.1080/07474938.2015.1096695
Accepted author version posted online: 21

Oct 2015.
Published online: 21 Oct 2015.
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Date: 18 July 2016, At: 17:55
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http://dx.doi.org/10.1080/07474938.2015.1096695
A multivariate volatility vine copula model

E. C. Brechmanna , M. Heidenb , and Y. Okhrinb
Center for Mathematical Sciences, Technische Universitt Mnchen, Garching, Germany; b Department of Statistics,
Faculty of Business and Economics, University of Augsburg, Germany
Downloaded by [Ryerson University Library] at 17:55 18 July 2016
ABSTRACT
KEYWORDS
This article proposes a dynamic framework for modeling and forecasting of

realized covariance matrices using vine copulas to allow for more flexible
dependencies between assets. Our model automatically guarantees positive
definiteness of the forecast through the use of a Cholesky decomposition of the
realized covariance matrix. We explicitly account for long-memory behavior
by using fractionally integrated autoregressive moving average (ARFIMA) and
heterogeneous autoregressive (HAR) models for the individual elements of
the decomposition. Furthermore, our model incorporates non-Gaussian innovations and GARCH effects, accounting for volatility clustering and unconditional kurtosis. The dependence structure between assets is studied using
vine copula constructions, which allow for nonlinearity and asymmetry without suffering from an inflexible tail behavior or symmetry restrictions as in
conventional multivariate models. Further, the copulas have a direct impact
on the point forecasts of the realized covariances matrices, due to being
computed as a nonlinear transformation of the forecasts for the Cholesky
matrix. Beside studying in-sample properties, we assess the usefulness of our
method in a one-day-ahead forecasting framework, comparing recent types
of models for the realized covariance matrix based on a model confidence
set approach. Additionally, we find that in Value-at-Risk (VaR) forecasting, vine
models require less capital requirements due to smoother and more accurate
forecasts.
Copula; forecasting; realized

covariances; realized
volatility; vine
JEL CLASSIFICATION
C32; C46; C52; C58
1. Introduction
Reliable forecasts of stock market volatility are necessary in asset pricing, portfolio management, and
evaluation of risks. Due to the increasing availability of high-frequency data, the use of squared returns to
consistently and efficiently estimate the ex-post realized volatility and its multivariate equivalent, realized
covariance, has become one of the standard methods in empirical finance. Stemming from stochastic
calculus, where Dolans-Dade (1967) showed that the sum of squared returns is a consistent estimator
for the quadratic variation and Jacod (1994) derived the corresponding limit theory, the concept was
soon applied in econometrics. By making volatility directly measurable, standard time series models
can be applied to the series of realized covariances. A special interest lies in estimating and forecasting
the whole realized covariance matrix (RCOV), see Barndorff-Nielsen and Shephard (2004), as most
applications are implemented for the multivariate case. However, a major obstacle lies in ensuring
positive semidefiniteness and symmetry of the covariance matrix while retaining parsimony of the model
for larger dimensions. Up to now, only few methods exist that fulfill these requirements and most of them
have concentrated on the univariate modeling of the components of realized covariance, neglecting the
specific dependence structure amongst the individual series.
CONTACT Yarema Okhrin

yarema.okhrin@wiwi.uni-augsburg.de
Department of Statistics, Faculty of Business and Economics,
University of Augsburg, Germany.
Color versions of one or more of the figures in the article can be found online at www.tandfonline.com/lecr.
2016 Taylor & Francis Group, LLC
E. C. BRECHMANN ET AL.
For univariate realized volatility, fractionally integrated ARMA (ARFIMA) (Andersen et al., 2003)
or Heterogeneous Autoregressive (HAR) processes (Corsi, 2009) are most commonly suggested to be
used on logarithmic realized volatility, capturing long-memory dependence and allowing for a standard
autoregressive structure. The ARFIMA framework benefits from the availability of standard methods
of forecasting, see, e.g., Beran (1994), whereas HAR models are a convenient and easy to estimate
way of including volatility measured over different time horizons and account for multifractal scaling
(Corsi, 2009). Directly modeling the components of the RCOV-matrix with univariate processes is
possible (e.g., as described in Andersen et al., 2006), but does not guarantee positive definite forecasts
and dynamic linkages among the series, such as volatility spillovers, might be neglected (Voev, 2008).
Latest multivariate approaches that ensure symmetry and positive semi-definiteness of the RCOV matrix
include the Wishart Autoregressive (WAR) model proposed by Gouriroux et al. (2009) and its dynamic
generalization, the Conditional Autoregressive Wishart (CAW) by Golosnoy et al. (2012). Chiriac
(2010) shows that the WAR estimation is very sensitive to assumptions on the underlying data, causing
degenerate Wishart distributions and affecting the estimation results. Consequently, Chiriac and Voev
(2011) choose the way of RCOV transformation and base their Vector ARFIMA (VARFIMA) model
on a Cholesky decomposition of the covariance matrix. Bauer and Vorkink (2011) instead transform the
covariance matrix by using the matrix logarithm function and a factor model approach for the individual
components. Andersen et al. (2006) modify the Dynamic Conditional Correlation (DCC) model of
Engle (2002) to contain a generalization of the realized correlation matrix. Halbleib and Voev (2014)
split up the RCOV matrix in a DCC-type framework, but with high-frequency data in the volatility
and daily data in the correlation parts. Disadvantages of these multivariate approaches are the lack of
flexibility in the parameters and the inability to conveniently model non-Gaussianity and conditional
heteroskedasticity in the volatility series itself. In contrast, the univariate framework offers a wide range
of possibilities to tackle these problems, for example estimation under skewed error distributions and
various GARCH augmentations (see, e.g., Corsi et al., 2008).
Using the Cholesky decomposition as a tool to ensure positivity and semidefiniteness for the realized
covariance matrix was initially proposed in Andersen et al. (2002) and is meanwhile a frequently used
method (see for example Halbleib and Voev, 2011, or Becker et al., 2010). Beside the aforementioned
properties, modeling the elements of the Cholesky decomposition rather than the original realized
covariance matrix bears the advantage of naturally interconnected entries within the matrix, which
can be simply modeled by univariate processes. However, due to the nature of the decomposition, the
relation between the elements is not linear and characteristic dependence patterns can be observed.
These patterns are subject to the high correlation between realized correlations and realized volatility
(Andersen et al., 1999). Among others, this can be attributed to the interconnectedness of economies,
which has strongly increased in recent time. Financial assets become more dependent, particularly
during extremely negative economic phases and asset market volatility linkages tighten during periods
of financial turmoil, as Cappiello et al. (2006) highlight. This asymmetric dependence has important
implications for portfolio allocation, as the variance of the return on a portfolio of financial assets
depends not only on the variances of the individual assets but also on the correlations between the assets.
Copulas are a convenient way to account for the dependence patterns among the realized covariances.
However, the choice of multivariate copulas is limited. In contrast, the bivariate case offers a rich variety
of different copulas with flexible dependence patterns, based upon a steadily growing literature especially
in the GARCH framework.
Vine copulas benefit from the flexibility of bivariate copulas through using them as building blocks
in a hierarchical construction. By combining arbitrary bivariate copulas in different levels of the
construction, a wide range of dependence characteristics such as tail dependence and asymmetry can
be accounted for. Since Aas et al. (2009) proposed the use of pair-copula constructions, an equivalent
name of vine copulas, the model class has attracted increasing attention in the literature (see Kurowicka
and Joe, 2011, for a recent overview) and has been successfully applied in many applications: amongst
others, Min and Czado (2010, 2011) model swap data of different maturity, Czado et al. (2012) investigate
foreign exchange rates, Mendes and Accioly (2012) examine the dependence among realized volatilities,
Mendes et al. (2010) and Brechmann and Czado (2011) analyze implications of dependence among stock
ECONOMETRIC REVIEWS
returns on portfolio management, and also regime-switching approaches are explored by Chollete et al.
(2009) and Stber and Czado (2014).
The purpose of this article is to study a dynamic framework for modeling and forecasting realized
covariance matrices using vine copulas to allow for more flexible dependencies between assets. We
extend the existing models for the realized covariance matrix based upon the Cholesky decomposition by
examining the nonlinear dependence structure. Further, we account for the often neglected volatility of
realized volatility in the models by considering GARCH components and skewed error distributions.
Our empirical aim is to introduce the vine framework for forecasting the whole realized covariance
matrix and also study its performance from a practitioners point of view. Based upon the realized
covariance forecasts from several models, we construct minimum variance portfolios and compare the
ex-post portfolio performance for all models. Additionally, we assess the models ability to predict tail
events by studying Value-at-Risk (VaR) forecasts within the Model Confidence Set (MCS) framework of
Hansen et al. (2011) by means of the Stein loss function. We find that the advantages of vine copulas
in reflecting the complex dependence between Cholesky elements is statistically and economically
significant.
The article is structured as follows. The next section explains the procedure of model building and
contains all relevant information on the modeling of realized covariances and vines. Furthermore, we
highlight the procedure of performing forecast using our modeling approach. In Section 3 we present
the results of the empirical study with large attention devoted to appropriate vine copulas and economic
significance of our forecasts.
2. Cholesky decomposition based models for realized covariance matrices

Let Rt RN with t = 1, . . . , n be a vector of daily log returns, N being the number of assets under
consideration. The process can be written as
Rt = E [Rt | F t1 ] + t ,
(1)
Ft1 being the information set consisting of all relevant information up to and including t 1. The
interest lies in the N N conditional variance-covariance matrix of log returns, Var [Rt | Ft1 ] = 6 t .
Assume a trading day is split into M intraday periods and r,t is the N 1 vector of log returns over the
intra-day period = 1, . . . , M of day t. Barndorff-Nielsen and Shephard (2004) propose the realized
covariance matrix as a consistent estimator of 6 t :
Yt =
M
X
r,t r,t
.
(2)
=1
Later numerous refinements of the estimators were suggested to reduce the market microstructure noise
(see, e.g., Dacorogna, 2001, and Zhang et al., 2005), take jumps (Christensen and Kinnebrock, 2010) and
nonsynchronicity (Hayashi and Yoshida, 2005) into account or to improve the overall precision (Zhang,
2011).
The Cholesky decomposition of Y t with Pt being an upper triangular matrix, yields
y11,t y12,t y1N,t

y12,t y22,t y2N,t
Yt = .
(3)
..
..
..
..
.
.
.
y1N,t yNN,t
p11,t
0
0
p11,t p12,t p1N,t
p12,t p22,t
0 p22,t p2N,t
= .
(4)
.
.
.
.
.
..
..
..
.. ..
..
..
..
.
.
=
p1N,t
Pt Pt .
p2N,t pNN,t
pNN,t
Since Y t is by construction positive semidefinite and symmetric, all elements pij,t , i, j = 1, . . . , N, i < j
are real and can be calculated recursively by
!
i1
yij,t
pki,t pkj,t
for i < j
pii,t
k=1
v
u
j1
pij,t = u
(5)
X
ty
2
p
for
i
=
j
jj,t
kj,t
k=1
0
for i > j.
In reverse, the realized covolatilities can be expressed in terms of the Cholesky elements
min{i,j}
yij,t =
pi,t pj,t .
(6)
=1
There are several important issues related to the Cholesky decomposition for realized covariances, which
have to be addressed.
First, covariances and variances are not directly separated, making the specification of individual
models for each part more difficult. Since each Cholesky element depends in a nonlinear way on
the corresponding realized covariance and all Cholesky elements from previous rows as given in (5),
this imposes a specific nonlinear and asymmetric dependence structure of pij,t s, rendered by the
dependencies within yij,t s and the formulas in (5). We suggest to use vine copulas to model this structure,
since this type allows us to visualize and model these dependencies by a tree-like structure of bivariate
copulas. Second, there are N! possible permutations of the stocks in the matrix, resulting in different
decompositions that are nonlinearly related to each other (see Becker et al., 2010). Hence, depending on
the modeling process that is applied on the decomposition afterwards, different orderings may influence
the model structure and parameter estimates. We deal with this problem by analyzing the fit of our model
for all possible orderings in Section 3.2.
Our general modeling approach consists of the following steps:
1. For every ordering of the assets, we obtain the Cholesky decomposition of Y t .
2. For each of the N(N + 1)/2 nonzero elements of the Cholesky matrix, we estimate univariate models
from the ARFIMA and HAR class, as described in Section 2.1, and account for the dynamics in the
conditional mean of the time-series. Similarly, we estimate ARFIMA and HAR models augmented
by a GARCH component, to additionally account for the dynamics of the conditional variances.
3. The residuals from each univariate model are modeled using a vine copula (see Section 2.2). The
selection of vine structure is discussed in Section 2.3.
4. Using the fitted vine copulas we simulate the residuals of each time series model, which mimic the
dependence in the original data. In combination with the forecasts from the univariate time-series
models, we obtain forecasts for each Cholesky element, which can be recombined to yield a forecast
of the RCOV matrix, see Section 2.4.
2.1. Marginal models

For the Cholesky elements pij,t , we consider ARFIMA and HAR as two alternative base models. Both
models are capable of reproducing the hyperbolic decay which the Cholesky elements inherit from
the realized covariance series and are frequently used for modeling and forecasting realized volatilities.
Furthermore, both approaches show good performance in our in- and out-of-sample studies. Alternatively, one can consider a multivariate times series model, which has obvious computational limitations
when the dimension increases. The approach suggested in this article can be applied, however, in high
dimensions too.
ECONOMETRIC REVIEWS
Note that to ensure positivity of the forecasts for the diagonal elements of the Cholesky decomposition, we take the logarithm of the diagonal elements pii,t
and keep the old notation for simplicity.
Andersen et al. (2003) specify the ARFIMA p, D, q model in the form
(L)(1 L)D (xt ) = (L)ut ,
(7)
where p, q N, (L) = 1 1 L p Lp , (L) = 1 + 1 L + + q Lq are lag polynomials

and D is the parameter of fractional differencing. During the estimation, we restrict the parameter to
D (0, 0.5), so that the process is stationary. The error term ut is usually assumed to be Gaussian white
noise, and xt denotes the daily series of any Cholesky element.
The HAR model of Corsi (2009) assumes that market participants act on different time (investment)
horizons due to their individual preferences. This renders shorter and longer term volatilities, which are
aggregated. For the basic concept, the realized covariance matrices are averaged over the one day (d), one
week (w), and one month (m) periods. We then apply the Cholesky decomposition on each aggregated
covariance matrix and model the daily series of one Cholesky element xt by
(w)
(m)
xt = 0 + (d) xt1 + (w) xt1 + (m) xt1 + ut ,
(8)
()
where xt is the Cholesky element of the aggregated covariance matrix over the corresponding period
of interest and ut is typically assumed to be Gaussian white noise. Note that the HAR specification
corresponds to a high-order autoregressive process with specific constraints on the parameters.
In reality, due to the time-varying volatility of volatility, the residuals of ARFIMA and HAR models
exhibit non-Gaussianity and clustering. Following Corsi et al. (2008), we extend both models by
including a GARCH(1, 1) component. As shown in Bai et al. (2003), the common GARCH(1, 1) with
Gaussian innovations is not able to account for very high values of kurtosis of the dependent variable,
as it is only controlled by 1 + 1 , the kurtosis of the error distribution, and the persistence of the
GARCH itself. Hence, given the observed skewness and kurtosis, we can assume a skewed generalized
error (SGED) distribution for the standardized errors t (see, e.g., Fernandez and Steel, 1998):
ut = ht t
h2t = + 1 u2t1 + 1 h2t1
(9)
(10)
t SGED (, , , ) .
(11)
The distribution is described by four parameters, the location parameter , the scale parameter , the
shape parameter , and the skewness parameter , which yields the following density function
!
C
| t + |

f (t | , , , ) = exp
,
(12)
1 sign (t + )
where
1
,
2
1 1
2
2
1
3
=
S( )1 ,
C=
= 2 AS( )1 ,
p
S( ) = 1 + 3 2 4A2 2 ,
and
1 1
2
2
2
1
3
A=
(13)
(14)
(15)
(16)
(17)
For the case where = 2 and = 0, the distribution reduces to the normal distribution. The
unknown parameters for each model specification are estimated by maximum likelihood. A vine copula
is then fitted to the residuals of the univariate time series for Cholesky elements. For the specification
without a GARCH part, we define the residuals by u t = xt t . For the GARCH-based models with

Gaussian innovations, we consider the standardized residuals t = xt t /h t . In case of the GARCH
based models with SGED innovations, standardized residuals t are obtained by rescaling the density in
Eq. 12 based on its moment conditions, see Fernandez and Steel (1998).
The following sections summarize the general theory on vine copulas and suggest a particular
structure of the vine copula which reflects the observed dependence pattern among the Cholesky
elements.
2.2. Vine copulas

The entries of the realized covariance matrix, and thus the elements of the Cholesky decomposition, are
closely related as pointed out in the previous section. Modeling them as independent might therefore
have a severe negative impact on the forecasting accuracy of multivariate realized volatility. Our aim
is to construct a flexible multivariate distribution for the elements of the Cholesky decomposition
which allows for nonlinear and asymmetric dependence among elements as defined in (5). Standard
multivariate distribution such as the Gaussian, which is underlying, e.g., the VARFIMA model (see
Chiriac and Voev, 2011), do not meet such requirements. It is therefore natural to work with copulas. In
particular, we will use the class of regular vine copulas which offers the desired flexibility.
The virtue of copula modeling is due to the famous theorem by Sklar (1959) which allows to separately
consider the margins and the dependence structure of any multivariate distribution. If the multivariate
distribution F is absolutely continuous with density f and F1 , . . . , Fd are strictly increasing continuous
with densities f1 , . . . , fd , respectively, then
" d
#
Y
f (x1 , . . . , xd ) =
fk (xk ) c(F1 (x1 ), . . . , Fd (xd )),
(18)
k=1
where c denotes the copula density. Many details on copula theory can be found in the comprehensive
references by Joe (1997) and Nelsen (2006).
Popular choices of multivariate copulas in practice include elliptical, especially Gaussian and Students
t, and Archimedean copulas. While both classes are oftenand successfullyapplied in bivariate
applications, their multivariate extensions suffer from severe shortcomings. Archimedean copulas
typically use only one or two parameters to describe the dependence among possibly dozens of variables.
Furthermore they assume exchangeability and that all multivariate margins are the same. The extension
to Hierarchical Archimedean copulas suggested by Okhrin et al. (2013) are suitable for capturing the
conditional nature of the dependence on the Cholesky elements. Note, that in contrary to the vine
copulas, this class poses additional constraints on the parameters to guarantee the feasibility of the
resulting distribution. Elliptical copulas, on the other hand, can only account for symmetric dependence
and require the specification of the full correlation matrix which may be complicated to work with under
positive definiteness constraints.
Vine copulas, which are another name for so-called pair copula constructions (PCCs) as introduced
by Aas et al. (2009), overcome such limitations and render feasible flexible copula modeling also in higher
dimensions, while not suffering from parameter restrictions as, e.g., Archimedean copulas. Hence,
these copulas are particularly suitable to model the dependence between the Cholesky elements. The
construction of vine copulas dates back to Joe (1996) and was formalized in a graph theoretical context by
Bedford and Cooke (2001, 2002). Before providing the exact definition of vines we consider an illustrative
example of a three-dimensional PCC. Let d = 3 and assume that all necessary densities exist. Then one
can conditionally decompose
f (x1 , x2 , x3 ) = f1 (x1 )f2|1 (x2 |x1 )f3|1,2 (x3 |x1 , x2 ).
(19)
ECONOMETRIC REVIEWS
Using Sklars theorem (18), it follows for a copula C1,2 with density c1,2 ,
f1,2 (x1 , x2 )
c1,2 (F1 (x1 ), F2 (x2 ))f1 (x1 )f2 (x2 )
=
f1 (x1 )
f1 (x1 )
= c1,2 (F1 (x1 ), F2 (x2 ))f2 (x2 ),
f2|1 (x2 |x1 ) =
(20)
and for copulas C1,3 and C2,3;1 ,

f2,3|1 (x2 , x3 |x1 )
c2,3;1 (F2|1 (x2 |x1 ), F3|1 (x3 |x1 ))f2|1 (x2 |x1 )f3|1 (x3 |x1 )
=
f2|1 (x2 |x1 )
f2|1 (x2 |x1 )
= c2,3;1 (F2|1 (x2 |x1 ), F3|1 (x3 |x1 ))f3|1 (x3 |x1 )
f3|1,2 (x3 |x1 , x2 ) =
(20)
= c2,3;1 (F2|1 (x2 |x1 ), F3|1 (x3 |x1 ))c1,3 (F1 (x1 ), F3 (x3 ))f3 (x3 ),
(21)
where
F2|1 (x2 |x1 ) =
C1,2 (F1 (x1 ), F2 (x2 ))

F1 (x1 )
(22)
and similarly for F3|1 .

Equations (19)(21) then describe the three-dimensional joint density of (x1 , x2 , x3 ) in terms of the
marginal distributions and the three copulas C1,2 , C1,3 , and C2,3;1 . In particular, we have decomposed the
three-dimensional copula of (x1 , x2 , x3 ) into these bivariate copulas which can be chosen independently
of each other. We assume that the conditional copula C2,3;1 is independent of the conditioning value
x1 to facilitate estimation and inference. This assumption is called the simplifying assumption and will
be used throughout the article. We shortly discuss the severity of this assumption at the end of this
section. Regarding the flexibility of copula choice, C1,2 could be an elliptical copula and C1,3 and C2,3;1
Archimedean. In this way, a wide range of different dependence structures can be modeled using PCCs.
The above decomposition of a three-dimensional density can easily be generalized to the general
multivariate case. A PCC however requires choices with respect to the order of variables in the
decomposition. Bedford and Cooke (2001, 2002) therefore introduced vines as a graphical representation
of PCCs. They are described in more detail in Kurowicka and Cooke (2006) and Kurowicka and Joe
(2011). Statistical inference and model selection are considered in Dissmann et al. (2013) and Brechmann
et al. (2012).
Following Kurowicka and Cooke (2006) a regular vine (R-vine) on d variables consists of a sequence
of linked trees (connected acyclic graphs) T1 , . . . , Td1 . The first tree T1 has nodes N1 = {1, . . . , d}
and a set of d 1 edges E1 between these nodes. Tree Ti , i = 2, . . . , d 1, then has d i + 1 nodes
Ni = Ei1 and d i edges Ei which satisfy the so-called proximity condition. This condition requires
that two edges in tree Ti1 (nodes in tree Ti ) are joined in tree Ti only if they share a common node
in tree Ti1 . It ensures that the decomposition encodes a valid multivariate distribution. In particular,
Bedford and Cooke (2001) and Kurowicka and Cooke (2006) show that each edge in an R-vine can be
uniquely identified by two nodes, the conditioned nodes, and a set of conditioning nodes.
For more technical details, see Dissmann et al. (2013) who use so-called R-vine arrays to conveniently
encode the information of the R-vine copula components. To conveniently encode the information of
the R-vine copula components in Fig. 1, Dissmann et al. (2013) use the so-called
R-vine arrays. They
involve the specification of a lower triangular matrix M = mi,j | i, j = 1, . . . , d {0, . . . , d}dd with
Figure 1. Three-dimensional R-vine tree sequence with edge indices.
mi,i = d i + 1. That is, the diagonal entries of M are the numbers 1, . . . , d in decreasing order. In this
matrix, according to a rather technical condition, each row from the bottom up represents a tree, where
we have as follows:
The conditioned set is identified by a diagonal entry and by the corresponding column entry of the
row under consideration; while
The conditioning set is given by the column entries below this row.
Using this notation, according to Dissmann et al. (2013) the R-vine density is
" d
# 1 j+1
Y
Y Y
f (x1 , . . . , xd ) =
fk (xk )
cmj,j mi,j ;mi+1,j md,j ,
(23)
k=1
j=d1 i=d

where the pair-copulas have arguments F xmj,j | xmi+1,j , . . . , xmd,j and F xmi,j | xmi+1,j , . . . , xmd,j .
Corresponding copula types and parameters can conveniently be stored in matrices related to M. The
R-vine matrix corresponding to the R-vine in Fig. 1 is
3
,
(24)
M= 1 2
2 1 1
where all other entries are zero. The bottom row of M corresponds to T1 , the second row from the bottom
to T2 , and so on. To determine the edges in T1 , we combine the numbers in the bottom row with the
diagonal elements in the corresponding columns, i.e., the edges are (3, 2) and (2, 1). To determine the
edges in T2 , we combine the numbers in the second row from the bottom with the diagonal elements in
the corresponding columns, and condition on the elements in the bottom row, giving the edge (1, 3 | 2).
For example, the density for the 3-dimensional case in Eq. 24 is given by
f (x1 , x2 , x3 ) = f (x1 ) f (x2 ) f (x3 ) c1,2 (F (x1 ) , F (x2 )) c2,3 (F (x2 ) , F (x3 ))
c1,3;2 (F (x1 | x2 ) , F (x3 | x2 )) .
(25)
Special cases of R-vines that are frequently used are canonical vines (C-vines) and D-vines (see
Aas et al., 2009, and Czado et al., 2012). C-vines are characterized by a unique root node in each tree
which is connected to all other nodes of that tree. Figure 2 depicts a three-dimensional example. A Cvine specification can therefore simply be stated in terms of the order of root nodes. Such a model is
particularly appropriate if there are pivotal quantities among the variables. D-vines are constructed by
choosing a specific order of the variables. In the first tree, the dependence of the variables is modeled
pair-wise, and in the second tree conditional dependences are modeled pair-wise again. Figure 1 is an
example of a D-vine.
To summarize, a d-dimensional R-vine copula is a multivariate copula built up by d(d1)/2 bivariate
copulas. There is a wide range of flexible bivariate copulas available and able to account for characteristics
like tail dependence and asymmetry. In a vine copula they can be chosen arbitrarily to appropriately
Figure 2. Three-dimensional C-vine tree sequence with edge indices.
ECONOMETRIC REVIEWS
account for dependence patterns in multivariate data. The model selection therefore involves three steps:
selection of vine trees, selection of bivariate copulas, and finally estimation of copula parameters. A
recent survey of selection strategies for vine copulas can be found in Czado et al. (2013).
Acar et al. (2012) address several critical points on the simplifying assumptions underlying the vine
copulas and present methods how to deal with it in three dimensions. In general, this assumption allows
us to chose the bivariate copulas independently of each other, and hence, the copulas of the conditional
distributions do not depend on the variables that are conditioned on. Of course, the assumptions may
in fact not hold, but a more general treatment of the simplifying assumption in arbitrary dimension
is still missing. Stber et al. (2013) discuss cases where the simplifying assumption is satisfied. This is
especially true, when all pair copulas are Gaussian and also when pair copulas are Students t, where
degrees of freedom increase with increasing vine tree level. The optimal model in the empirical part,
which uses Students t pair copulas, can be seen as an extension of the latter case and, therefore, we
expect the simplifying assumption to approximately hold.
2.3. Choosing the vine structure
To select an appropriate vine structure for the elements of the Cholesky decomposition, or more precisely
for the independent and identically distributed (i.i.d.) residuals of the elements after marginal time
series filtering, we first recall the definition of realized covolatilities yij in terms of the elements pij of
the Cholesky decomposition (see Eq. (6)),
min{i,j}
yij =
pi pj .
=1
This means that the realized covolatilities in column j, {yij }i=1,...,j , only depend on the entries of the
Cholesky matrix P up to column 1, . . . , j, {pi }ij . Let d = d(d+1)/2. To define a suitable vine structure,
we introduce the following notation:
p11,t p12,t p1d,t

0 p22,t p2d,t
(26)
Pt = .
..
..
..
..
.
.
.
0
0 pdd,t
is numbered as
1 2 4 7 11
3 5 8 12
6 9 13
10 14
15 . .
..
d 2d + 2
d 2d + 3
d 2d + 4
..
.
..
.
..
.
d d + 1
d d + 2
d d + 3
d d+4
.
..
..
d 2d + d d d + d 1
d d + d
(27)
To identify the correlation patterns, we store the elements of the matrix in vectors, sorted by column
and by row, i.e., for vech(Pt ) and vech(Pt ), with

1
1
2
2

3
4

ordering as in vech(Pt ) = 4
and ordering as in vech(Pt ) = 7 .
(28)

..
..
.
.
d
10
A sensible model for the entries of the Cholesky matrix therefore should be built iteratively as follows:
1. Start with p11 (column 1; entry 1 of vech(Pt )).
2. Include {p2 }=1,2 into the model (column 2; entries 2, 3 of vech(Pt )).
3. Include {p3 }=1,2,3 into the model (column 3; entries 4, 5, 6 of vech(Pt )).
4. Proceed iteratively.
In other words, models are constructed by iteratively including the entries of columns of the Cholesky
matrix from left to right.
The question then is how entries are included into the model, that is, how their dependence to entries
already included in the model is modeled. A typical strategy in vine copula modeling is to select trees
so that rather strong dependencies are modeled explicitly; see Dissmann et al. (2013) and Brechmann
et al. (2012). This avoids that such strong dependencies, which are often in focus, are disguised through
conditioning on many other (less relevant) variables. Numerical problems can also be reduced using this
strategy. According to the functional form of the Cholesky elements, which is supported by the empirical
evidence, two natural approaches can be exploited for the selection of the first tree.
First, empirical findings often suggest a higher correlation between the variances than between the
covariances, and hence the entries on the diagonal play a pivotal role for the other entries. A suitable
model for the first tree would connect new columns to the existing elements through the diagonal
and within-column dependence could model as C-vines, where the first root node is the entry on the
diagonal, the second root node the entry in the first row, the third root node the entry in the second
row, and so on. The first R-vine tree for such a model with d assets is shown in the left panel of Fig. 3.
Here, for the entries on the diagonal, a sub-D-vine is constructed. Dependence to entries from previous
columns is modeled as follows: first to entries in column j 1, then to those in column j 2, etc. In the
following, we call this type of vine structure model (A).
Second, the strongest dependence is frequently observed among the elements of the first row. In this
case, we can construct the R-vine trees of model (B). Here, in contrast to model (A) new entries are
however connected via the entries in the first row using a D-vine structure. The first root node is again
the entry on the diagonal, the second root node is the second entry in the first row, and so on. The
first tree is shown in the right panel of Fig. 3. The within-column dependence is modeled by C-vines
in analogy to model (A) to simplify the estimation. For both models, visual examples of the structure
of the second tree are given in Section 3.2. In general, careful analysis of the corresponding correlation
patterns might show that other approaches are suitable too.
Figure 3. First R-vine trees of models (A) (left panel) and (B) (right panel) for the general vine structure in Eq. (27).
ECONOMETRIC REVIEWS
11
2.4. Forecasting with the multivariate vine copula model and bias correction
In the vine copula framework, forecasts for the realized covariance matrix b
Yt+1 are generated in multiple
steps. For each model and Cholesky element pij,t , we generate one-step ahead forecasts p ij,t+1 . For the
models without the GARCH part, we simulate the residuals u ij,t+1 from the estimated vine copula and
compute the point-forecast ij,t+1 from the corresponding marginal model. This results in the onestep-ahead forecast of the Cholesky elements p ij,t+1 = ij,t+1 + u ij,t+1 . For GARCH-based models
the forecasts involves the simulated residuals ij,t+1 , and the forecasts of the conditional mean ij,t+1
and variance h ij,t+1 resulting in p ij,t+1 = ij,t+1 + ij,t+1 h ij,t+1 . In the final step, the forecast for the
realized covariance matrix b
Y t+1 is obtained by Eq. (4). Since computing the realized covariances from
the Cholesky elements involves sums of products and squares of copula-distributed residuals, this implies
that the second moments of the residuals do have an explicit impact on point forecasts.
However, this last transformation is nonlinear and induces a theoretical bias, which can be
expressed as
max{i,j}
E[yij,t+1 yij,t+1 ] =
E[ui,t+1 uj,t+1 ].
=1
The summands that determine the bias are the covariance of the forecast errors from the models for
the Cholesky elements (see Chiriac and Voev, 2011). In our case, the expression is not feasible, since
we estimate the models independently of each other and, therefore, cannot consistently estimate the
covariance matrix of the forecast errors. A heuristic approach relies on shifting the forecast to match the
level of the observed volatility. Formally, we proceed as follows:

yij,t
y(corrected),ij,t+1 = yij,t+1 median
.
y ij,t t=1,...,n
This method is also advocated in Chiriac and Voev (2011).
3. Empirical study
3.1. Data and marginal models
The dataset stems from the New York Stock Exchange (NYSE) Trade and Quotations (TAQ) and
corresponds to the one used in Chiriac and Voev (2011). It was obtained from the Journal of Applied
Econometrics Data Archive. The original data file consists of all tick-by-tick bid and ask quotes on
six stocks listed on the NYSE, American Stock Exchange (AMEX), and the National Association of
Security Dealers Automated Quotation system (NASDAQ). The sample ranges from 9:30 EST until
16:00 EST over the period January 1, 2000 to July 30, 2008 (2,156 trading days). Included individual
stocks are American Express Inc. (AXP), Citigroup (C), General Electric (GE), Home Depot Inc. (HD),
International Business Machines (IBM), and JPMorgan Chase&Co (JPM). The data is synchronized by
the previous-tick interpolation method of Dacorogna (2001). For each day, (M = 78) equally spaced
five-minute return vectors are constructed based on log-midquotes. Further, daily open-to-close returns
are computed as the difference in the log-midquote at the end and the beginning of each day. For each
daily period t = 1, . . . , 2156, the series of daily realized covariance matrices is constructed as sum of the
squared five-minute return vectors according to Eq. 2. This approach is further refined by a subsampling
procedure, see Zhang (2011), to make the realized covariance estimates more robust to microstructure
noise and nonsynchronicity. To shorten the presentation, we restrict the discussion in this section to
alphabetic ordering of the assets.
After applying the Cholesky decomposition at each point of time t, we take the logarithm of the
elements on the diagonal, to ensure positivity of the elements of the decomposition when applying the
time-series models. In general, the Cholesky elements exhibit the same characteristics as the realized
covariances, namely volatility clustering, right skewness, and excess kurtosis, see Table A.7. The LjungBox statistics indicate long memory of the covariance-Cholesky series. These findings are in line with
12
the long-memory behavior of volatility, which is well documented in the existing GARCH literature (see,
e.g., Engle and Lee, 1999, and Karanasos et al., 2004). In contrast, the log transformed diagonal elements
show less signs of skewness and overkurtosis, but are still highly autocorrelated.
Since we want to keep the estimation as parsimonious as possible for the ARFIMA models, we limit
ourselves to the case of the ARFIMA(1, D, 1) with D (0, 0.5), so that the process is stationary. In
particular, we consider the following set of marginal models:
ARFIMA-based models:
ARFIMA: ARFIMA(1, D, 1), ut N(0, 2 );
ARFIMAN: ARFIMA(1, D, 1) with GARCH(1, 1), t N(0, 2 );
ARFIMASGED: ARFIMA(1, D, 1) with GARCH(1, 1), t SGED (, , , );
HAR-based models:
HAR: HAR, ut N(0, 2 );
HARSGED: HAR with GARCH(1, 1), t SGED (, , , ).
For all models, we assume independence between the Cholesky elements and estimate them by maximum likelihood with the postulated distribution of the residuals.
The estimates of the parameter D of fractional integration of the ARFIMA(1, D, 1) and ARFIMASGED(1, D, 1) model in Table A.8 support the hypothesis of strong persistence in most of the time-series.
The table also contains the Akaikes information criterion (AIC) of the base models (ARFIMA and HAR)
as well as the GARCH extensions with SGED, where we additionally perform tests for autocorrelation
(LjungBox) and heteroscedasticity (Lagrange Multiplier). In all cases, the augmented models have
lower AIC values and significantly remove heteroscedasticity. In case of the HAR, we find remaining
autocorrelation in the residuals, which is less a problem for the ARFIMA.
Hence, the GARCH specifications with SGED residuals are clearly favored both for HAR and
ARFIMA models. The models succeed in capturing the heteroscedasticity and the asymmetry of the
residuals. This is particularly important for the subsequent vine modeling, which is applied to the
estimated residuals of the best models, following the inference functions for margins (IFM) method
of Joe and Xu (1996). In the majority of the cases the postulated distribution could not be rejected by the
KS goodness-of-fit test.
3.2. Optimal vine structure
As described in Section 2.3, we chose the optimal vine structure by selecting trees so that strong
dependencies amongst the entries of the Cholesky matrix are modeled explicitly. We therefore look at
the empirical rank correlation matrices of residuals after marginal time series filtering.
Based on the six-dimensional data set, the Cholesky matrix Pt contains 6 variances and 15 covariances. For simplicity, entry numbers from 1 to 21 refer to the position of the element in the Cholesky
matrix:
1 2 4 7 11 16
p11,t p12,t p16,t
3 5 8 12 17
0 p22,t p26,t
6 9 13 18
.
is numbered as
Pt = .
..
..
..
10 14 19
..
.
.
.
15 20
0
0 p66,t
21
To identify the correlation patterns, we store the elements of the matrix in vectors, sorted by column
and by row, as described in Section 2.3. The correlation matrices of residuals from HARSGED models
sorted by column and by row are shown in Fig. 4; marginal ARFIMASGED modeling results in
essentially the same matrices which are therefore not shown here.
There is a clear difference in the correlation pattern for different parts of Pt or, alternatively,
for different subvectors of vech(Pt ). In particular, there is a strong relationship between Cholesky
matrix entries in the first row of the covariance matrix (elements 1, 2, 4, 7, 11, 16), visualized by the
corresponding cells being darker. This can be explained by lower heterogeneity of the Cholesky elements,
ECONOMETRIC REVIEWS
13
Figure 4. Heat maps of the rank correlation coefficients of HARSGED residuals for sorting by column (left) and by row (right), i.e., for
vech(Pt ) and vech(Pt ).
i.e., these elements depend on less original realized variances and covariances, see Eq. 5. There is also
clear increased dependence between entries on the diagonal (elements 1, 3, 6, 10, 15, 21) and the entries
in the first row, as well as between the entries on the diagonal themselves. As already mentioned, this
fact results from higher correlation between the variances than between the covariances. We therefore
consider the two different vine models we described for the general case in Section 2.3.
In model (A) new columns are connected to the existing elements through the diagonal and withincolumn dependence is modeled as C-vines, where the first root node is the entry on the diagonal, the
second root node the entry in the first row, the third root node the entry in the second row, and so on,
since in particular the entries on the diagonal and in the first row seem to play a pivotal role for the other
entries (see Fig. 4). For instance, in the sixth column the order of the root nodes is as follows: 21, 16, 17,
18, 19, 20. The first R-vine tree of the model for six assets is shown in the left panel of Fig. 5; the trees
of the model for the first six entries (three assets) are displayed in Fig. 1. Dependence to entries from
previous columns is modeled as follows: first to entries in column j 1, then to those in column j 2,
etc. Similar to the example in Eq. 24, the whole structure of the trees of model (A) can be inferred using
the R-vine matrix in the upper half of Table A.9. As an example, the second tree of model (A) is given in
the left panel of Fig. A.8.
Similarly, we construct the R-vine trees of model (B). Here new entries are however connected via
the entries in the first row. The first root node is again the entry on the diagonal, the second root node
the second entry in the first row, and so on. The within-column dependence is modeled as C-vines in
analogy to model (A). The first tree is shown in the right panel of Fig. 5. Similar to before, the vine matrix
in the lower half of Table A.9 allows us to construct the subsequent trees. Exemplary, the second tree of
model (B) is given in the right panel of figure A.8. Note that the matrix specification of R-vines at the
same time directly allows for the derivation of the pair-copula decomposition (see Aas et al., 2009) of
the corresponding R-vine distribution.
3.3. Estimation results
Next we compare the two proposed models based on our 21-dimensional data set. The bivariate copulas
are either chosen as Students t or selected according to the AIC from a range of bivariate copulas
covering both tail dependence and tail asymmetry (investigated copulas: tail symmetric Gaussian and
Students t, lower tail dependent Clayton, upper tail dependent Gumbel, tail independent Frank and
14
Figure 5. First R-vine trees of models (A) (left panel) and (B) (right panel).
appropriate survival versions and rotations). To speed up the estimation procedure, if the Students t
copulas estimated degree of freedom is larger than 30, a Gaussian copula is estimated instead.
For comparison, an R-vine with arbitrary structure is selected and fitted according to the maximum
spanning tree principle as proposed by Dissmann et al. (2013). In order to model strong dependencies
rather explicitly, that means in earlier trees of the R-vine, this approach chooses the R-vine such that the
strongest dependencies, measured in terms of Kendalls s, are captured in each R-vine tree. A model
selected in this way can be seen as a benchmark model.
To assess the impact of the asset ordering for the Cholesky decomposition, we consider all 720
orderings generated by the permutation of six assets. Figure 6 shows boxplots of the obtained log
likelihoods relative to the log likelihood of the R-vine selected according to the maximum spanning tree
principle. Again we only show results for HARSGED marginals, since results using other appropriate
marginal time series models are very similar.
Further, for the HARSGED marginals, we provide the means, medians of the corresponding log
likelihoods with the results for the natural (alphabetic) ordering in Table 1. Coincidentally, this ordering
leads to the highest average log likelihood of all orderings. It turns out that model (A) performs best
and also mostly better than the R-vine model according to Dissmann et al. (2013). If only Students t
copulas are allowed, the log likelihoods are slightly lower. This indicates that also some tail asymmetries
as implied by Clayton and Gumbel copulas are present. However, preliminarily deciding to use only
Students t copulas significantly simplifies the model selection step and the decrease in the log likelihood
is only about 1.5%. Furthermore, we restrict ourselves to the alphabetic ordering of the data as listed
in Section 3.1. The vine copula with only Students t copulas as building blocks extends the standard
multivariate Students t copula by allowing for a more flexible tail behavior through multiple degrees of
freedom parameters. A vine copula with only Gaussian copulas, which corresponds to a tail independent
multivariate Gaussian copula, will be considered for comparison. Note that in higher dimensions,
the number of parameters could be significantly decreased by truncation approaches as discussed in
Brechmann et al. (2012). Summarizing, the specific class of vines lead to a relatively minor reduction in
the performance of the considered models and hence, we restrict ourselves to vine models with Students
t and Gaussian copulas in the modeling procedure.
As an example, the full sample estimation results for the Students-t vine are given in Table A.10, where
each matrix entry corresponds to the respective copula of the R-vine array (model A) (see Table A.9), as
explained explanatory in Eq. 23.
ECONOMETRIC REVIEWS
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Figure 6. Boxplots of log likelihoods of R-vine models (with mixed or Students t copulas) relative to the log likelihood of the R-vine
selected according to the maximum spanning tree principle. HARSGED models are used for the marginal time series.
Table 1. Medians and means of log likelihoods of R-vine models (with mixed or students t copulas) over 720 different permutations of
the assets. MST stands for maximum spanning tree principle. HARSGED models are used for the marginal time series. The last column
corresponds to the log likelihoods for the alphabetic ordering.
Median
Mean
Alphabetic
(MST)
(A)
(B)
(A)-t
(B)-t
8124.228
8156.644
8128.584
8029.903
8013.231
8123.258
8153.930
8115.539
8034.360
8019.153
8235.424
8222.735
8233.400
8162.612
8143.122
3.4. Alternative joint multivariate models

The marginal models and the vine models suggested in the previous subsections are used to build a
single multivariate model for the dynamics of the Cholesky elements and will be used in the subsequent
empirical applications. Thus, we take into account both the specific dependence between the elements
and peculiar individual features such as asymmetry, heavy tails, and heteroscedasticity effects. All in all,
additionally to the 10 models with independent residuals, we consider four vine models based on model
(A). The choice of the vine models is motivated by the pre-analysis in Sections 3.2 and 3.3, but can be
generalized to any other type of vines.
ARFIMA-based models:
ARFIMA-N: ARFIMASGED with Gaussian vine, that is all pair copulas are set to Gaussian
copulas;
ARFIMA-T: ARFIMASGED with Students t vine, that is all pair copulas are set to Students t
copulas;
HAR-based models:
HAR-N: HARSGED with Gaussian vine;
HAR-T: HARSGED with Students t vine.
16
Due to the complexity of the joint model and particularly due to a specific estimation of vines, the
vine-based models are fitted in a two-step procedure. In the first step, the residuals from the estimated
marginal models are transformed by the corresponding cdf. In the second step, the obtained time series
are models by an appropriate vine copula (compare Section 3.2). Then, forecasts can be generated as
described in Section 2.4.
As additional benchmark model, weconsider the multivariate VARFIMA(1, D, 1) of Chiriac and Voev
(2011). The general VARFIMA p, D, q process can be written as
8(L)D(L)[Xt c] = 2(L)ut ,
ut N(0,6),
(29)
L2
Lp , 2(L)
where c is a vector of constants of dimension N 1, 8(L) = IN 81 L 82 8p

=
IN + 21 L + 22 L2 + + 2q Lq are matrix lag polynomials with 8i , i = 1, . . . , p, and 2j , j = 1, . . . , q,
being the AR- and MA-coefficient matrices and D(L) = diag{(1L)D1 , . . . , (1L)DN }, with D1 , . . . , DN
being the degrees of fractional integration of each element of the vector Xt .
The vector process Xt is stationary if Di < 0.5 for i = 1, . . . , N, and an element of Xt , Xit , is stationary
if Di < 0.5 (Sowell, 1992). Since the error term is assumed to be normally distributed, the parameters
can be consistently estimated by maximum likelihood.
We follow the approach of Chiriac and Voev (2011), who consider the simpler final equation form
with restrictions on the AR-, MA-, and fractionally integration operators, to keep the estimation
parsimonious. The final equation form implies that 8(L) is a scalar operator, so that c can be estimated
in a first step as the sample mean of Xt . Due to the imposed restrictions in Eq. 29, D, 8(L) and 2(L)
are of dimension one. Similar to Chiriac and Voev (2011), we use an extended version of the maximum
likelihood methodology proposed by Beran (1995), where the matrix 6 in Eq. 29 is set equal to the
unconditional covariance matrix of a stationary VARFIMA(1,D,1), which is approximated based on
a VARMA(,1) truncated at 1,000 lags. Estimation results for the VARFIMA model parameters are
identical to the results of Chiriac and Voev (2011). Forecasts can then be obtained through the infinite
Vector Moving Average (VMA()) representation, see Ltkepohl (2005).
The VARFIMA model has shown good results in forecasting realized covariances despite keeping the
number of parameters to estimate fairly small. While being able to model the dynamics of the realized
covariance matrix, the model does not explicitly account for asymmetry, heavy tails, or volatility of
volatility, as our vine models do.
Overall, we should be able to assess the impact of three distinctive features of the models compared to
the base models. First, accounting for volatility of volatility (ARFIMASGED and HARSGED). Second,
accounting for asymmetry and heavy tails (vine models). Third, influence of the number of parameters,
which are shown for each model in Table 2.
The overall number of parameters for the multivariate models consisting of univariate models for
each Cholesky element can be obtained by multiplying the number of parameters by the number of
individual time-series of Cholesky elements. The Students t copula models have an overall number of 231
Table 2. Number of parameters for each model and component of the Cholesky matrix, including parameters of the marginal
distribution.
Model
ARFIMA
ARFIMAN
ARFIMASGED
ARFIMA-N
ARFIMA-T
HAR
HARSGED
HAR-N
HAR-T
Base model
GARCH
Vine component
Overall (21)
5
5
5
5
5
5
5
5
5
3
4
4
4
4
4
4
1
2
1
2
5
8
9
10
11
5
9
10
11
model
VARFIMA
overall
30
ECONOMETRIC REVIEWS
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parameters. However, if the Students t copulas estimated degree of freedom is larger than 30, a Gaussian
copula is estimated instead, which is on average the case for 57% of the copulas in our estimation. For the
VARFIMA, the number of parameters consists of the three one-dimensional scalar parameters D, 8(L),
and 2(L), as well as the parameters of the multivariate marginal distribution, resulting in an overall
number of 30 parameters.
3.5. Forecasting performance

We are particularly interested in comparing the forecasts of the realized covariance matrices for risk
assessment. Here, we evaluate the forecasting performance of the suggested models deploying statistical
and economic measures. To efficiently compare covariance forecasts from many models, different
approaches are possible. Direct methods evaluate the forecasts based upon several kinds of loss functions
and an unbiased volatility proxy, such as the realized covariances. Indirect methods circumvent using a
proxy for volatility to which the forecasts are compared. By contrast they stick to forecasting portfolio
characteristics or measures of risk. According to Patton and Sheppard (2009), two issues are of major
importance when comparing covariance forecasts. First, tests have to be robust to noise in the volatility
proxy, and second, they should only require minimal assumptions on the distribution of the returns.
Since most indirect methods are based upon a variety of assumptions and some of them fail to correctly
identify optimal forecasts (Clements et al., 2009), we apply the method of Hansen et al. (2011) using
model confidence sets (MCS) to evaluate the forecasts (see Section A.1). This approach has the advantage
that we can conveniently compare many models without using a benchmark by considering them under a
specific loss function, in our case the Stein loss (see also Section A.1). Nevertheless, sometimes the model
with the smallest statistical loss function may not be the one preferred in the evaluation by economic
consideration (see Laurent et al., 2013). In Sections 3.5.1 and 3.5.2, we also focus on economic evaluation
by means of conventional portfolio optimization and Value-at-Risk (VaR) forecasting (see Lopez and
Walter, 2001). Since the vine models are explicitly modeling tail events due to their assumption of nonnormality, we expect the vine based models to be superior in terms of VaR forecasting under several
evaluation criteria, namely accuracy as well as economic costs associated with negligence of extreme
events.
Having obtained an appropriate vine structure, we are able to generate forecasts for all models by
simulation. We consider expanding window estimation starting with 1,508 days from January 1, 2000
to December 31, 2005. The models are reestimated on 648 days from January 1, 2006 to July 30, 2008
using all past observations. The forecasts are computed recursively and bias corrected as described in
section 2.1.
Table 3 gives the corresponding levels of confidence of the MCS, at which the model can be removed
from the confidence set. For example, at a 90% confidence level, all models with a reported value > 0.1
are included in the MCS. It can be seen that the HAR-T model is the leading model, followed by the
HAR-N and the VARFIMA model, which both cannot be rejected from the MCS at a reasonable
Table 3. Model confidence set p-values based on QLIKE loss
for out-of-sample period. The p-values indicate the significance level at which the H0 that the respective model is part
of the MCS can be rejected.
Model
p-Value
HAR-T
HAR-N
VARFIMA
ARFIMASGED
ARFIMAN
ARFIMA
ARFIMA-T
ARFIMA-N
HARSGED
HAR
1.00
0.20
0.20
0.01
0.01
<0.01
<0.01
<0.01
<0.01
<0.01
18
p-value. All remaining models are rejected from the MCS at a p-value of 1%. Hence, regarding forecasting
accuracy, the HAR-based vine copula models are favored over their ARFIMA-based counterparts as
well as their base models. Differences between the two HAR vine models do not seem to be statistically
significant, as are the differences from the multivariate benchmark VARFIMA model.
3.5.1. Portfolio theory
In practice, applicants are rather interested in the use of the forecasted covariance matrix in some
economic framework rather than the quality of the point forecasts. Assuming a risk averse investor with
suitable utility function (second degree polynomial or logarithmic), the problem of utility maximization
can be reduced to finding the weights which minimize the portfolio volatility pf ,t+1 given a target
expected return exp (Markowitz, 1952). The optimal portfolio is given by solving the quadratic problem
b
t+1 | t = arg min pf ,t+1 = arg min wt+1
w
| t Y t+1 wt+1 | t
wt+1 | t
s.t.
wt+1 | t

wt+1
| t E rpf ,t+1 | Ft1 + (1 wt+1 | t 1)rf = exp ,
wt+1
| t 0,
where b
Y t+1 is the covariance forecast at t for t + 1, wt+1 | t is the N 1 vector of portfolio weights chosen
at t for the period from t to t + 1, 1 is an N 1 vector of ones, rpf ,t+1 the ex-post portfolio return, and
rf is the risk-free rate (3% p.a.).
If we repeat the optimization for several levels of (daily) target returns and average the minimal
portfolio variance over all t, we obtain ex-post efficient frontiers for every forecasting model, see Fig. 7.
We distinguish between the improvement upon the benchmark models through taking the GARCH
effects and SGED residuals into account and the further improvement due to the introduction of vines.
Note that the performance criteria in this case is the objective function in the optimization problem
and not the loss function of Stein. The first extension with GARCH/SGED has no impact on the base
HAR model, but leads to strong improvement in the performance of the basic ARFIMA model. The
inclusion of vines has an opposite effect. Thus the forecasting ability of pure time series models for the
Cholesky elements can be less improved by vines, compared to the HAR models with or without GARCH
extensions. In the latter cases, the economic improvement caused by vines is substantial.
Vines cause a sizeable shift of the efficient frontier to left for HAR models, while for the ARFIMAbased models the impact is ambiguous. The ARFIMA model with GARCH component and SGED
residuals outperforms the vine-based counterparts for smaller values of the target return. The ordering is
swapped for daily expected returns above 5%. However, this is a rather unreliable region for comparison,
as it implies an annual target return of 12.5% for the optimization and hence mostly leads to extreme
portfolio decisions.
Since the figures can only give a rough indication of performance, as they are based on averages over
the whole out-of-sample period, we rather focus on the differences in Sharpe ratios at every point of
time t. The differences in the Sharpe ratios can be tested by the heteroscedasticity and autocorrelation
consistent (HAC) test and bootstrapped test of Ledoit and Wolf (2008). Each model is tested against all
the alternatives. The maximum average Sharpe ratio for all models is obtained around an annual target
return of exp = 10% (daily target return of 0.04% in Fig. 7). Hence, we decide to perform the test for
this region, to make results more comparable.
Significant differences (p-values smaller than 5%) for exp = 10% are reported in Table 4. The
VARFIMA and ARFIMA models are in general superior to HAR models. The HAR vine models Sharpe
ratios are in nearly all cases significantly different from the HAR base models, whereas the ARFIMA vines
cannot improve upon the ARFIMASGED. While there is no difference between the ARFIMA vines, the
HAR-T, which explicitly models tail dependence, outperforms the HAR-N. The overall results support
the evidence from the efficient frontiers, that there is a larger benefit from using a vine framework in the
case of HAR models.
ECONOMETRIC REVIEWS
19
Figure 7. Efficient frontiers for HAR-based (top) and ARFIMA-based (bottom) computed using a rolling window of 500 days and
averaged over the whole sample.
3.5.2. VaR
In this section, we concentrate on the risk associated with the forecasted portfolios. Based upon the
portfolio application, we can calculate VaRt () forecast of the portfolio return with respect to the
empirical portfolio return distribution ft for different levels = 0.01, 0.05, 0.1. Following Lopez and
Walter (2001), we separate the portfolio variance dynamics pf ,t+1 and the distributional form of ft+1 ,
where we assume ft+1 = ft . Hence the VaR forecast for t + 1 is given by
q
1
VaRt+1 () = pf ,t+1b
Ft+1
(),
(30)
1
where b
Ft+1
is the inverse of the (historical) cumulative distribution function of standardized portfolio
returns.
For the forecasted VaRs, the number of exceptions and exceedance ratios can be calculated and
averaged over a grid of target returns for each level . In contrast to our portfolio comparison before, we
20
Table 4. P-values of HAC and bootstrapped tests for the equality of Sharpe ratios for portfolios with the target return of 10%. First model
has higher Sharpe ratio and only pairs with significant differences are listed (at least one p-value is less than 5%).
VARFIMA vs. HARSGED

VARFIMA vs. HAR
ARFIMA vs. HAR
ARFIMASGED vs. HARSGED
ARFIMASGED vs. HAR
ARFIMA-N vs. HARSGED
ARFIMA-T vs. HARSGED
HAR-N vs. HARSGED
HAR-T vs. HAR
ARFIMA-N vs. HAR
ARFIMA-T vs. HAR
HAR-N vs. HAR
ARFIMA-N vs. HAR-T
ARFIMA-N vs. HAR-N
ARFIMA-T vs. HAR-T
HAR-T vs. HAR-N
HAC
p-value
bootstrap
p-value
0.028
0.002
0.008
0.013
0.003
0.004
0.003
0.013
0.011
0.001
0.001
0.003
0.003
0.015
0.006
0.033
0.058
0.012
0.027
0.027
0.010
0.013
0.015
0.036
0.038
0.008
0.009
0.015
0.010
0.029
0.024
0.070
can easily summarize the results for a region of annual target returns between 9% to 12.5%. We deliberately expand into the region of higher returns, where more extreme events and portfolio allocations are
likely to happen. Our intuition behind this approach is that more risky portfolio allocations are more
susceptible to extreme events in the data set. Hence, predictive accuracy for the VaR is crucial in this
case and should lead to pronounced differences in the following analysis from a statistical as well as an
economic point of view.
The results are summarized in Table 5. An exception takes place, if rpf ,t < VaRt (), where rpf ,t is
the ex-post portfolio return based upon the optimization in Section 3.5.1. In general the conventional
models lead to a very small number of exceptions, while for the models based on the SGED distribution,
exceptions are slightly more frequent than empirically expected. This can be explained by the general
level of (absolute) overprediction from the conventional models. On average, forecasted VaRs for the vine
models are smaller, while the number of exceptions remains roughly the same. Note that the average VaR
for the models based on vines is extremely robust. The marginal model has virtually no impact on the
VaR if vines are used. The same refers to the fraction of exceedances, which closely follow the true level.
These two observations strengthen the advantages of vines for risk management.
We further explore this hypothesis by plotting the forecasted VaRt () for the ARFIMA and HAR
models in Fig. A.9 for the case of the annual target return being 10%. The figures strenghten the
hypothesis that the vine models seem to produce smaller VaR forecasts with fewer extremes. For other
levels of , the plots are basically identical. Hence, vine models seem to achieve the same number of
exceptions as the other models, but with smaller VaR requirements and less volatile VaR forecasts. In
accordance with these presumptions, we evaluate these VaR forecasts under the asymmetric Stein loss
function to test several hypothesis using MCS. Our first hypothesis evaluates the tendency of some
models to overpredict the VaR. The larger the forecasted VaR in relation to the ex-post portfolio return,
Table 5. Mean daily VaR forecasts and the fraction of exceptions for target returns between 9%12.5%.
VaR (1%)
VaR (5%)
VaR (10%)
Exc. (1%)
Exc. (5%)
VARFIMA
ARFIMA
ARFIMASGED
ARFIMAN
HARSGED
HAR
ARFIMA-N
ARFIMA-T
HAR-N
HAR-T
2.87
1.98
1.94
2.84
2.20
3.16
1.92
1.92
1.94
1.93
1.75
1.24
1.2
1.72
1.41
2.08
1.20
1.20
1.20
1.20
1.27
0.93
0.91
1.25
1.08
1.42
0.91
0.91
0.90
0.90
0.00
0.02
0.02
0.00
0.02
0.00
0.02
0.02
0.02
0.02
0.02
0.05
0.05
0.02
0.05
0.01
0.05
0.05
0.05
0.05
Exc. (10%)
0.07
0.10
0.10
0.07
0.10
0.07
0.11
0.11
0.11
0.11
ECONOMETRIC REVIEWS
Table 6. P-values at which the model is rejected from the MCS for different levels of VaR forecasts .
H1
H2
VARFIMA
ARFIMA
ARFIMAN
ARFIMASGED
HARSGED
HAR
ARFIMA-N
ARFIMA-T
HAR-N
HAR-T
21
H3
= 0.01
= 0.05
= 0.1
= 0.01
= 0.05
= 0.1
= 0.01
= 0.05
= 0.1
0.09
1.00
0.94
0.09
0.94
0.09
0.89
0.89
0.89
0.89
0.22
0.98
1.00
0.33
0.98
0.31
0.88
0.88
0.88
0.91
0.34
1.00
0.97
0.68
0.97
0.68
0.89
0.89
0.89
0.90
0.00
0.00
0.49
0.00
0.00
0.00
0.60
1.00
0.49
0.49
0.00
0.00
0.43
0.00
0.00
0.00
0.43
0.43
0.43
1.00
0.00
0.00
0.00
1.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.39
0.00
0.00
0.00
0.83
1.00
0.39
0.22
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.07
1.00
0.00
0.00
0.00
0.00
0.00
0.00
1.00
0.68
0.00
0.68
the more capital has to be held back unnecessarily, and we punish these models harder. On the other
hand, a good model should also not tend to underpredict or generate extreme exceedances of the
forecasted VaR. If the ex-post portfolio return exceeds the forecasted VaR, the model is penalized. To
assess the general level of overpredicting, we punish the model if the forecasted VaR is larger than the
benchmark VaR, which is the VaR we obtain using the true rather than the forecasted covariance matrix.
Summarized, our hypotheses are as follows:
H1: stronger punishment if |rpf ,t | < |VaRt ()|. Idea: Punish if forecasted VaR is larger than necessary.
H2: stronger punishment if |rpf ,t | > |VaRt ()|. Idea: Punish large exceedance of VaR.
H3: stronger punishment if |VaRt ()| > |VaRt,bench ()|. Idea: Punish overpredictions in relation to
oracle benchmark.
We illustrate our approach for hypothesis H1. For each point of time t, we compute the (univariate) loss
for each model, Lt = |VaRt ()||rpf ,t |. Here, VaRt () is the forecasted VaR at level and rpf ,t the ex-post
portfolio return, both based upon the same forecast of the covariance matrix from one specific model.
Since the Stein loss overweights underpredictions, the value of the loss function is larger if |rpf ,t | <
|VaRt ()| than vice versa. As a result, models that tend to large VaR predictions in relation to the achieved
portfolio return are associated with a higher loss.
The results of the MCS can be found in Table 6. In general, there does not seem to be a difference
between the models if a VaR is larger than necessary (H1). Regarding H2, we can nearly always reject
the VARFIMA, ARFIMA, HARSGED, and HAR models. Consequently, if there is an exceedance in case
of these four models, it is larger than for the vine models. In case of H3, we can again reject the base
models in nearly all cases. These models generate VaR forecasts which are larger than required by the
benchmark (oracle) model.
Hence, while we do not find statistically significant differences regarding overpredictive behavior,
vine models still reduce the amount of required capital. On the one hand, the general level of forecasted
VaR is lower than for conventional models. On the other hand, they produce significantly better VaR
forecasts and avoid large exceedances of the forecasted VaR.
4. Conclusion
In this article, we study a dynamic framework for forecasting realized covariances using vine copulas.
Our approach is based upon the Cholesky decompositon of the realized covariance matrix and allows
us to separate the estimation of marginal time-series models and the specification of an appropriate
dependence structure. Given a range of popular models for forecasting realized covariances extended by
a GARCH term, we compare different vine structures based upon a variety of nonlinear and asymmetric
copulas.
Analyzing multiple forecasting applications, we show that using a vine structure leads to significant
improvements for HAR models regarding statistical loss, mean-variance efficient portfolios, and VaR.
For ARFIMA-based vine models, results are not as unambiguous except for forecasting daily VaRs.
There, compared to conventional models, the vine structure leads to smaller capital requirements while
providing significantly more accurate forecasts and avoiding large exceedances of the forecasted VaR.
22
Hence, especially in combination with easily applicable forecasting models, such as the HAR, this
article offers a flexible and promising way of using the advantages of copulas for forecasting multivariate
realized volatility. In this context, we hope that our study provides a basis for turning an eye on the often
neglected issue of dependence structure between assets.
A. Appendix
A.1. Model confidence sets

To evaluate the forecasting ability of our models solely based upon the forecast error, we rely on the work
of Laurent et al. (2013), who derive the family of consistent loss functions, where consistency means that
the true ranking of the covariance models is preserved, regardless if the true conditional covariance
or an unbiased covariance proxy is used. Let L(Y t ,b
Y t ) be the loss function between the forecast from
our model b
Y t and the actual realized covariance matrix Y t . Following Becker et al. (2010), we use the
Stein loss function proposed in James and Stein (1961), sometimes called multivariate quasi likelihood
(MVQLIKE), which fulfills the consistency requirement. As Laurent et al. (2013) point out, the Stein
loss is asymmetric and penalizes underpredictions more heavily. In their work, Clements et al. (2009)
find that likelihood-based loss functions possess greater power in distinguishing between multivariate
volatility forecasts, compared to Mean-Squared-Error (MSE) loss functions.
The Stein loss function is defined as

L Y t ,Ybt = tr(Ybt Y t ) ln Ybt Y t N,
(31)
where, Y t is the true realized covariance matrix at time t, Ybt the forecasted realized covariance matrix
and N is the number of assets.
Based upon Eq. 31, we specify the MCS of Hansen et al. (2011), so that we do not have to rely
on pairwise comparisons. The MCS approach is basically a modified version of the test for Superior
Predictive Ability (SPA) of Hansen (2005). However, it possesses greater power and does not require a
benchmark model for ranking.
We start with the full set of candidate models M0 = {1, . . . , m0 }, where in our case m0 = 10. For all
models, the loss differential between each model is computed based upon the loss functions L, so that
for model i and j, i,j = 1, . . . , m0 and every time point t = 1, . . . , T we get

dij,t = L Y it ,b
Y it L Y jt ,b
Y jt .
(32)
At each step of the evaluation, the hypothesis

H0 : E dij,t = 0,
i, j M, i > j,
(33)
is tested for a subset of models M M0 , where M = M0 for the initial step. If H0 is rejected at a given
significance level , the worst performing model is removed from the set. This process continues until a
set of models remains that cannot be rejected. We follow the work of Hansen et al. (2011), who use the
range statistics to evaluate H0 , which can be written as

dij

,
(34)
TR,k = max tij = max q
i,jM
i,jM
c d ij )
var(
P
c d ij ) is obtained from a block-bootstrap procedure, see Hansen et al.
where d ij = T1 Tt=1 dij and var(
(2011). We implement the bootstrap with 10,000 replications and a variable block length ranging from
20 to 100, finding that the results are robust to the choice of block length.
The worst performing model to be removed from the set M is selected as model i with
d i
,
(35)
i = arg max p
iM var(
c d i )
P
where d i = 1
d ij and m is the number of models in the actual set M.
m1
jM
ECONOMETRIC REVIEWS
23
Table A.7. Summary statistics for Cholesky elements, named after the assets at the same position in the realized covariance matrix.
LjungBox is the value of the LjungBox statistics.
Mean
Max
Min
Diagonal elements (log)

1.31
0.58
1.13
0.53
1.14
0.48
0.97
0.42
1.11
0.46
1.21
0.53
AXP
C
GE
HD
IBM
JPM
0.30
0.20
0.04
0.29
0.00
0.14
2.03
2.16
1.73
1.75
1.56
2.20
AXP
C
GE
HD
IBM
JPM
AXP-C
AXP-GE
AXP-HD
AXP-IBM
AXP-JPM
C-GE
C-HD
C-IBM
C-JPM
GE-HD
GE-IBM
GE-JPM
HD-IBM
HD-JPM
IBM-JPM
1.59
1.41
1.17
1.46
1.12
1.32
0.71
0.52
0.55
0.45
0.71
0.37
0.36
0.31
0.58
0.29
0.26
0.22
0.15
0.14
0.14
7.59
8.69
5.62
5.75
4.74
9.02
7.63
3.99
3.71
3.09
8.16
2.68
2.40
4.68
5.77
2.76
2.13
2.22
1.71
1.19
1.37
Std
Skewness
Kurtosis
Ljung-Box
0.10
0.29
0.31
0.36
0.58
0.30
2.23
2.33
2.40
2.74
2.88
2.39
26649.29
27415.39
25029.52
20131.98
23874.34
26331.38
1.46
1.82
1.49
1.57
1.78
2.11
2.83
2.17
2.01
1.96
2.88
1.99
1.77
3.42
2.26
1.69
1.82
1.86
1.36
0.63
1.25
6.38
9.75
6.33
6.69
6.90
13.53
16.71
11.41
9.44
9.95
18.55
9.69
8.79
39.36
15.50
10.30
10.20
10.20
10.53
6.63
8.48
19679.10
20296.81
20280.56
17587.91
21898.59
19217.47
13997.58
10596.84
9574.33
6728.75
11932.97
9096.75
5170.33
4350.07
10567.05
4648.85
5261.79
2902.35
683.90
415.13
834.37
All elements (without log)

0.27
0.32
0.32
0.38
0.33
0.30
0.21
0.51
0.70
0.43
0.29
0.29
0.38
1.22
0.19
0.53
0.43
0.36
0.48
0.91
0.87
0.96
0.82
0.61
0.67
0.60
0.77
0.66
0.43
0.46
0.35
0.66
0.30
0.30
0.27
0.43
0.26
0.22
0.23
0.17
0.18
0.19
Table A.8. Akaike criterion (AIC) of marginal models for each Cholesky element, named after the alphabetically ordered assets, p-values
of the LjungBox test for the residuals (LB), and p-values of the Lagrange multiplier test for heteroscedasticity (LM). D is the respective
parameter estimate of fractional differencing for the ARFIMA(1, D, 1) and ARFIMASGED(1, D, 1) model.
ARFIMA
ARFIMASGED
HAR
HARSGED
AIC
LB
LM
D
AIC
LB
LM
D
AIC
LB
LM AIC
LB
LM
AXP
C
GE
HD
IBM
JPM
AXP-C
AXP-GE
AXP-HD
AXP-IBM
AXP-JPM
C-GE
C-HD
C-IBM
C-JPM
GE-HD
GE-IBM
GE-JPM
HD-IBM
HD-JPM
IBM-JPM
0.011
0.955
0.275
0.431
0.251
0.216
0.569
0.004
0.281
0.204
0.203
0.159
0.611
0.866
0.278
1.080
0.431
0.407
0.614
0.595
0.226
0.10
0.85
0.19
0.00
0.11
0.86
0.00
0.07
0.11
1.00
0.00
0.02
0.00
0.01
0.09
0.19
0.65
0.67
0.64
0.24
0.03
0.02
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.15
0.00
0.03
0.00
0.00
0.14
0.00
0.00
0.00
0.00
0.00
0.00
0.44
0.36
0.38
0.28
0.24
0.41
0.20
0.07
0.23
0.39
0.19
0.23
0.10
0.06
0.37
0.40
0.24
0.05
0.09
0.06
0.48
0.054
0.165
0.338
0.115
0.693
0.251
0.02
0.332
0.523
0.240
0.277
0.812
1.040
1.220
0.325
0.305
0.170
0.888
0.961
1.040
0.284
0.13
0.01
0.00
0.00
0.03
0.65
0.181
0.22
0.11
0.97
0.03
0.11
0.15
0.32
0.00
0.00
0.00
0.91
0.70
0.27
0.00
0.60
0.43
0.18
0.13
0.03
0.11
0.60
0.14
0.00
0.93
0.80
0.99
0.39
0.02
0.82
0.55
0.48
0.00
0.03
0.19
0.73
0.43
0.28
0.45
0.20
0.21
0.38
0.20
0.09
0.13
0.38
0.21
0.19
0.12
0.11
0.42
0.30
0.25
0.03
0.07
0.03
0.45
0.022
0.964
0.264
0.461
0.225
0.193
0.600
0.011
0.266
0.185
0.231
0.134
0.601
0.865
0.274
1.100
0.460
0.392
0.610
0.609
0.206
0.00
0.00
0.00
0.00
0.00
0.03
0.00
0.00
0.00
0.08
0.00
0.00
0.00
0.02
0.45
0.00
0.00
0.06
0.63
0.31
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.04
0.00
0.00
0.00
0.00
0.02
0.00
0.00
0.00
0.00
0.00
0.00
0.019
0.158
0.326
0.101
0.680
0.229
0.197
0.319
0.512
0.221
0.264
0.802
1.030
1.210
0.319
0.311
0.157
0.877
0.955
1.050
0.262
0.00
0.00
0.00
0.00
0.01
0.02
0.00
0.00
0.01
0.10
0.00
0.03
0.09
0.34
0.42
0.01
0.00
0.35
0.91
0.27
0.00
0.88
0.43
0.33
0.19
0.13
0.40
0.57
0.14
0.01
0.88
0.86
0.99
0.29
0.03
0.58
0.73
0.67
0.05
0.08
0.12
0.93
24
Table A.9. Vine arrays for model (A) (top) and model (B) (bottom) based on full-sample estimation.
Table A.10. Correlation parameters for the Students t R-vine (top) and the corresponding degrees of freedom (bottom, rounded) for
full sample estimation. If degrees of freedom are larger than 30, a Gaussian copula is used.
ECONOMETRIC REVIEWS
Figure A.8. Second R-vine trees of models (A) (left panel) and (B) (right panel) for the vine structure in Section (3.2).
Figure A.9. VaR( = 1%) forecasts from the ARFIMA (top) and HAR (bottom) models for the portfolios with target return of 10 %.
25
26
Funding
E. C. Brechmann gratefully acknowledges the support of the TUM Graduate Schools International School of Applied
Mathematics as well as of Allianz Deutschland AG.
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Econometric Reviews

ISSN: 0747-4938 (Print) 1532-4168 (Online) Journal homepage: http://www.tandfonline.com/loi/lecr20

A multivariate volatility vine copula model

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A multivariate volatility vine copula model

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This article proposes a dynamic framework for modeling and forecasting of

Copula; forecasting; realized

C32; C46; C52; C58

CONTACT Yarema Okhrin

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2. Cholesky decomposition based models for realized covariance matrices

y11,t y12,t y1N,t

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2.1. Marginal models

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where p, q N, (L) = 1 1 L p Lp , (L) = 1 + 1 L + + q Lq are lag polynomials

xt = 0 + (d) xt1 + (w) xt1 + (m) xt1 + ut ,

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2.2. Vine copulas

f2|1 (x2 |x1 ) =

and for copulas C1,3 and C2,3;1 ,

f3|1,2 (x3 |x1 , x2 ) =

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C1,2 (F1 (x1 ), F2 (x2 ))

and similarly for F3|1 .

Figure 1. Three-dimensional R-vine tree sequence with edge indices.

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Figure 2. Three-dimensional C-vine tree sequence with edge indices.

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p11,t p12,t p1d,t

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p11,t p12,t p16,t

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3.4. Alternative joint multivariate models

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where c is a vector of constants of dimension N 1, 8(L) = IN 81 L 82 8p

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3.5. Forecasting performance

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VARFIMA vs. HARSGED

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A.1. Model confidence sets

Diagonal elements (log)

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All elements (without log)

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