Perturbed Gaussian Copula
by Jean-Pierre Fouque of the University of California, Santa Barbara, and
August 8, 2006
Abstract: Gaussian copula is by far the most popular copula used in the financial industry in default dependency modeling. However, it has a major drawback --- it does not exhibit tail dependence, a very important property for copula. The essence of tail dependence is the interdependence when extreme events occur, say, defaults of corporate bonds. In this paper we show that some tail dependence can be restored by introducing stochastic volatility on a Gaussian copula. Using perturbation methods we then derive an approximate copula --- called perturbed Gaussian copula in this paper.
Published in: Advances in Econometrics, Vol. 22, (2008), pp. 103-121.