A semiparametric approach to value-at-risk, expected shortfall and optimum asset allocation in stock-bond portfolios

- We estimate the joint distribution of stock-bond returns by flexible copula models.
- We estimate the stock-bond portfolio tail risks of G7 countries accurately.
- Tail risks of the stock-bond portfolios increase after the GFC.
- Tail risk forecasts provide adequate regulatory capitals after the GFC.
- Increase in flight-to-quality and safety-first investor behaviour after the GFC

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 affected by the global financial crisis. The semiparametric t-copulas adequately model stock-bond returns joint distributions of G7 countries and Australia. Empirical results show that the (negative) weak stock-bond returns dependence has increased significantly for seven countries after the crisis, except 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 “flight to quality” and “safety first” investor behaviour was strong, after the global financial crisis. The semiparametric t-copula adequately forecasts the outer-sample VaR. These findings have implications for global financial regulators and the Basel Committee, whose central focus is currently on increasing the capital requirements as a consequence of the recent global financial crisis.