Market-Risk Optimization among the Developed and Emerging Markets with CVaR Measure and Copula Simulation

In this paper, the generalized Pareto distribution (GPD) copula approach is utilized to solve the conditional value-at-risk (CVaR) portfolio problem. Particularly, this approach used (i) copula to model the complete linear and non-linear correlation dependence structure, (ii) Pareto tails to capture the estimates of the parametric Pareto lower tail, the non-parametric kernel-smoothed interior and the parametric Pareto upper tail and (iii) Value-at-Risk (VaR) to quantify risk measure. The simulated sample covers the G7, BRICS (association of Brazil, Russia, India, China and South Africa) and 14 popular emerging stock-market returns for the period between 1997 and 2018. Our results suggest that the efficient frontier with the minimizing CVaR measure and simulated copula returns combined outperforms the risk/return of domestic portfolios, such as the US stock market. This result improves international diversification at the global level. We also show that the Gaussian and t-copula simulated returns give very similar but not identical results. Furthermore, the copula simulation provides more accurate market-risk estimates than historical simulation. Finally, the results support the notion that G7 countries can provide an important opportunity for diversification. These results are important to investors and policymakers.