Communications for Statistical Applications and Methods

The Korean Statistical Society (한국통계학회)
권호 표지
DOI QR코드

DOI QR Code

A risk analysis of step-down equity-linked securities based on regime-switching copula

  • Nguyen, Manh Duc (Department of Statistics and Actuarial Science, Soongsil University) ;
  • Ko, Bangwon (Department of Statistics and Actuarial Science, Soongsil University) ;
  • Kwon, Hyuk-Sung (Department of Statistics and Actuarial Science, Soongsil University)
  • Received : 2019.09.15
  • Accepted : 2019.12.03
  • Published : 2020.01.31
Download PDF
⟨ Previous Next ⟩

Abstract

The globalization of financial markets has broadened investment opportunities. International investors' investment portfolios consist of financial instruments from various countries; consequently, the risks associated with economic dependence among countries should be carefully considered. Step-down equity-linked securities (ELS) are a structured financial product that have recently become popular among Korean investors. Payoffs are based on two or three stock indices from different regions; therefore, dependence between the indices should be reflected in the risk analysis. In this study, we consider a regime-switching copula model to describe the joint behavior of two stock indices- the Eurostoxx50 and the Hang Seng China Enterprises Index (HSCEI). These indices are commonly used as underlying assets of step-down ELS. Using historical data, we analyze the risk associated with step-down ELS through the probabilities of early redemption. A regime-switching copula model can accommodate complicated dependence. Thus, it should be considered in the risk analysis of step-down ELS.

Keywords

References

  1. BenSaida A (2018). The contagion effect in European sovereign debt markets: a regime-switching vine copula approach, International Review of Financial Analysis, 58, 153-165. https://doi.org/10.1016/j.irfa.2017.09.013
  2. Cai J (1994). A Markov-model of switching-regime ARCH, Journal of Business and Economic Statistics, 12, 309-316. https://doi.org/10.2307/1392087
  3. Chollete L, Heinen A, and Valdesogo A (2008). Modeling international financial returns with a multivariate regime switching copula, Journal of Financial Econometrics, 7, 437-480. https://doi.org/10.1093/jjfinec/nbp014
  4. Delatte AL and Lopez C (2013). Commodity and equity markets: some stylized facts from a copula approach, Journal of Banking and Finance, 37, 5346-5356. https://doi.org/10.1016/j.jbankfin.2013.06.012
  5. Deng G, Mallett J, and McCann C (2011). Modeling auto-callable structured products, Journal of Derivatives and Hedge Funds, 17, 326-340. https://doi.org/10.1057/jdhf.2011.25
  6. Denuit M, Dhaene J, Goovaerts M, and Kaas R (2005). Actuarial Theory for Dependent Risks: MeaModels, Wiley, London.
  7. Genest C and Favre AC (2007). Everything you always wanted to know about copula modelling but were afraid to ask, Journal of Hydrologic Engineering, 12, 347-368. https://doi.org/10.1061/(ASCE)1084-0699(2007)12:4(347)
  8. Guillaume T (2015). Auto-callable structured products, The Journal of Derivatives, 22, 73-94. https://doi.org/10.3905/jod.2015.22.3.073
  9. Gurgul H and Machno A (2016). Modeling dependence structure among European markets and among Asian-Pacific markets: a regime-switching regular vine copula approach, Central European Journal of Operations Research, 24, 763-786. https://doi.org/10.1007/s10100-015-0411-x
  10. Hardy MR (2001). A regime-switching model of long-term stock return, North American Actuarial Journal, 5, 41-53. https://doi.org/10.1080/10920277.2001.10595984
  11. Hardy MR (2003). Investment Guarantees: Modeling and Risk Management for Equity-Linked Life Insurance, Wiley, Hoboken.
  12. Jondeau R and Rockinger M (2006). The copula-GARCH model of conditional dependencies: an international stock market application, Journal of International Money and Finance, 25, 827-853. https://doi.org/10.1016/j.jimonfin.2006.04.007
  13. Kang BJ (2016). The investment benefits of structured products: auto-callable equity linked securities, Asian Review of Financial Research, 29, 77-102.
  14. Kim HS and Yeo IK (2011). A case study on the risk of stepdown ELS, The Korean Journal of Applied Statistics, 24, 1021-1031. https://doi.org/10.5351/KJAS.2011.24.6.1021
  15. Lee H, Ahn S, and Ko B (2019). Generalizing the reflection principle of Brownian motion, and closed-form pricing of barrier options and autocallable investments, North American Journal of Eco-nomics and Finance, 50, 1-13.
  16. Lee KH, Lim HC, and Choi YS (2016). ELS hedging method based on CVaR using stocks portfolio and futures, Korean Journal of Futures and Options, 24, 423-455.
  17. Lim HC and Choi YS (2015). Knock-in and stocks market effect due to ELS issuance and hedging, Korean Journal of Futures and Options, 23, 289-321.
  18. Nelson RB (2006). An Introduction to Copulas, Springer, New York.
  19. Nguyen C, Bhatti MI, Komornikova M, and Komonik J (2016). Gold price and stock market nexus under mixed-copulas, Economic Modelling, 58, 283-292. https://doi.org/10.1016/j.econmod.2016.05.024
  20. Otani Y and Imai J (2018). An empirical analysis of the dependence structure of international equity and bond markets using regime-switching copula model, International Journal of Applied Mathematics, 48, 191-205.
  21. Pircalabu A and Benth FE (2017). A regime-switching copula approach to modeling day-ahead prices in coupled electricity markets, Energy Economics, 68, 283-302. https://doi.org/10.1016/j.eneco.2017.10.008
  22. Rui Z (2019). Modelling mortality dependence with regime-switching copula, Astin Bulletin, 49, 373-407 https://doi.org/10.1017/asb.2019.10
  23. Schaller H and Norden SV (2010). Regime-switching in stock market returns, Applied Financial Economics, 7, 177-191. https://doi.org/10.1080/096031097333745
  24. Shahzad SJ, Shahbaz M, Aloui C, and Jammazi R (2019). Are Islamic bonds a good safe haven for stocks? Implications for portfolio management in a time-varying regime-switching copula framework, Applied Economics, 51, 219-238. https://doi.org/10.1080/00036846.2018.1494376
  25. Sukcharoen K, Zohrabyan T, Leatham D, and Wu X (2014). Interdependence of oil prices and stock market indices: a copula approach, Energy Economics, 44, 331-339. https://doi.org/10.1016/j.eneco.2014.04.012
  26. Zhu K, Yamaka W, and Sriboonchitta S (2016). Multi-asset portfolio returns: a Markov switching copula-based approach, Thai Journal of Mathematics, 183-200.