Preprint Article Version 1 Preserved in Portico This version is not peer-reviewed

Assessing Market Risk in BRICS and Oil Markets: An application of Markov Switching and Vine Copula

Version 1 : Received: 28 January 2021 / Approved: 1 February 2021 / Online: 1 February 2021 (15:37:49 CET)

How to cite: Muteba Mwamba, J.W.; Mwambi, S.M. Assessing Market Risk in BRICS and Oil Markets: An application of Markov Switching and Vine Copula. Preprints 2021, 2021020055 (doi: 10.20944/preprints202102.0055.v1). Muteba Mwamba, J.W.; Mwambi, S.M. Assessing Market Risk in BRICS and Oil Markets: An application of Markov Switching and Vine Copula. Preprints 2021, 2021020055 (doi: 10.20944/preprints202102.0055.v1).

Abstract

This paper investigates the dynamic tail dependence risk between BRICS economies and world energy market in the context of the COVID-19 financial crisis of 2020, to determine optimal investment decisions based on risk metrics. For this purpose, the study employs a combination of novel statistical techniques ranging from Markov Switching, GARCH and Vine copula. Using a dataset consisting of daily stock and world crude oil prices; we find high probability of transition between lower and higher volatility regimes. Furthermore, our results based on the C-Vine copula confirm the existence of two types of tail dependence: - symmetric tail dependence between South Africa and China; South Africa and Russia; and lower tail dependence between South Africa and India; South Africa and Brazil; South Africa and Oil. For the purpose of diversification in these markets, we formulate an asset allocation problem using C-vine copula-based returns and optimize it using Particle Swarm algorithm with a rebalancing strategy. The results show an inverse relationship between the risk contribution and asset allocation of South Africa and oil market supporting the existence of lower tail dependence between them. This suggests that when South African stocks are in distress, investors tend to shift their holdings in oil market. Similar results are found between China and oil. In the upper tail, South African asset allocation is found to have an inverse relationship with that of Brazil, Russia and India suggesting that these three markets might be good investment destinations when things are not good in South Africa and vice-versa.

Subject Areas

BRICS; Markov Switching; Tail dependence; Vine Copula; Conditional Value-at-Risk

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