Copula Introduction

EMSE 280 - Copula Lecture: Part 1 J.R. van Dorp; www.seas.gwu.
edu/~dorpjr
Lecture on Copulas: Part 1
______________________________________
J. Ren van Dorp
1
Faculty Web-Page: www.seas.gwu.edu/~dorpjr
March 29-th, 2010
1
Department of Engineering Management and Systems Egineering, School of Engineering and
Applied Science, The George Washington University, 1776 G Street, N.W. Suite 101, Washington
D.C. 20052. E-mail: dorpjr@gwu.edu.
EMSE 280 - Copula Lecture: Part 1 J.R. van Dorp; www.seas.gwu.edu/~dorpjr - Page 1
OUTLINE
______________________________________
1. INTRODUCTION
2. COPULA CONSTRUCTION - ARCHIMEDEAN
3. ARCHIMEDEAN EXAMPLES
4. COPULA CONSTRUCTION - GENERALIZED DIAGONAL BAND
5. GENERALIZED DIAGONAL BAND EXAMPLES
6. SAMPLING PROCEDURE - ARCHIMEDEAN COPULA
7. SAMPLING PROCEDURE - GDB COPULA
8. SELECTED REFERENCES
1. INTRODUCTION...
CDF Theorem
______________________________________
Theorem: Let be a continuous random variable with distribution funnction \
J ] \ ] J\ . Let be a transformation of such that . The distribution of
] ! " is uniform on .
Proof: For a uniform random variable on we have Y ! "
T<Y ? ? a? ! "
Hence, we need to show that T<] C C aC ! " Since we have that
JB T<\ B ! " B ] J\ for all values of it follows that has
support . ! "
T<] C T<J\ C T<J J\ J C
T<\ J C JJ C C
" "
" "

1. INTRODUCTION...
Bivariate Normal PDF
______________________________________
Probability density function of a bivariate normal distribution:
\ QZ R ( (
\
\
" "
# #
. D Mean Vector , .
.
.
Covariance Matrix D
5
5
G9@\ \
G9@\ \
_ _
#
"
" #
" #
#
#
0B C /B:
"
# l l
_

1 D
. D . B B
w "
Independence in case of the bivariate normal distribution implies (and vice
versa):
D D
5 5
5 5

! " !
! ! "
_ _ _ _
# #
" "
# #
# #
"
,
1. INTRODUCTION...
BVN PDF - Independence
______________________________________
-
3
.
0
-
2
.
0
-
1
.
1
-
0
.
1
0
.
8
1
.
8
2
.
8
-3.0
-0.6
1.8
-
3
.
0
-
2
.
3
-
1
.
6
-
0
.
8
-
0
.
1
0
.
6
1
.
3
2
.
0
2
.
8
-3.0
-2.3
-1.6
-0.8
-0.1
0.6
1.3
2.0
2.8
. !! T<] !l\ ! !&
!
!
j
_ _
!
!
,
1
1
D 3
1. INTRODUCTION...
BVN PDF - Dependence
______________________________________
-
3
.
0
-
2
.
0
-
1
.
1
-
0
.
1
0
.
8
1
.
8
2
.
8
-3.0
-0.6
1.8
-
3
.
0
-
2
.
3
-
1
.
6
-
0
.
8
-
0
.
1
0
.
6
1
.
3
2
.
0
2
.
8
-3.0
-2.3
-1.6
-0.8
-0.1
0.6
1.3
2.0
2.8
. !%)$ T<] !l\ ! !(&
j
_ _
!
!
,
1
1
D 3
3
3
1. INTRODUCTION...
Sklar's (1959) Theorem
______________________________________
Sklars Theorem (1959). Given a joint CDF for random variables JB B
" 8
\ \ J J JB B
" 8 \ \ " 8
with marginal CDFs Then can
" A
be written as a function of its marginals:
JB B GJ B J B
" 8 \ " \ 8
,
" 8
where ( , . . . , ) is a joint distribution function with uniform marginals. G ? ? ! "
" 8
Moreover, if each is continuous, then ( , . . . , ) is unique, and if each J B G ? ?
\ 3 " 8
3
J B
\ 3
3
is discrete, then C is unique on
V+8J V+8J
\ \
" 8
where is the range V+8J J
\ \
8 8
For and ( , . . . , ) continuous and differentiable case one has: J G ? ?
\ " 8
"
0B B 0 B 0 B -J B J B
" 8 \ " \ 8 \ " \ 8
" 8 " 8
where is copula pdf or -? ?
" 8
dependence function.
1. INTRODUCTION...
Sklar's (1959)- The Bivariate Case
______________________________________
, : such that \ ] \ K ] L
w w w w
Continuous random variables
, H( ): K Cumulative distribution functions - cdf's.
The mapping is called the \ \ K\
w w
\ ! " Uniform
probability integral transformation e.g. Nelsen (1999).
Any bivariate joint distribution of can be transformed to a bivariate \ ]
w w
copula { } - Sklar (1959). \ ] K\ L]
w w
Thus, a bivariate copula is a bivariate distribution with uniform marginals.
As such, many authors studied copulae indirectly.
Gaussian and Student-t Copulae (of this construct) were studied explicitly
1. INTRODUCTION...
BVN Normal Copula
______________________________________
-
3
.
0
-
2
.
0
-
1
.
1
-
0
.
1
0
.
8
1
.
8
2
.
8
-3.0
-0.6
1.8
0
1
0
1
0.00
1.00
2.00
3.00
4.00
BVN - Independence BVN Copula - Independence \ ] \ ]
w w
\ Y! " ] Y! " \ ] -? ? " a? ? ! "
" # " #
#
1. INTRODUCTION...
BVN Normal Copula
______________________________________
0
1
0
1
0
1
2
3
4
5
cc
-
3
.
0
-
2
.
0
-
1
.
1
-
0
.
1
0
.
8
1
.
8
2
.
8
-3.0
-0.6
1.8
BVN - Dependence BVN Copula - Dependence \ ] \ ]
w w
\ Y! " ] Y! " \ ] -? ? ? ? ! "
" # " #
#
,
1. INTRODUCTION...
Summary
______________________________________
The dependence relationship between two random variables is \ ]
w w
obscured
by the marginal densities of and \ ]
w w
One can think of the copula density as the densities that filters or extracts the
marginal information from the joint distribution of and . \ ]
w w
To describe, study and measure statistical dependence between random \ ]
w w
variables one may study the copula densities.
Two random vectors and ) share the same dependence \ ] \ ]
" " # #
relationship when their copula densities are the same.
1. INTRODUCTION...
Inverse CDF Theorem
______________________________________
Vice versa, to build a joint distribution between two random variables
\ K ] L ! " ' and ' , one may construct first the copula on and
#
utilize the inverse transformation and ( ). K L
" "
Theorem: Let be a continuous random variable with distribution funnction \
J ] Y ! " ] J Y ] . Let be a transformation of such that . Then
"
also has distribution function . J
Proof: For a uniform random variable on we have Y ! "
T<Y ? ? a? ! "
Hence, we need to show that T<] C JC
T<] C T<J Y C T<J J Y J C
T<Y J C J C
" "

1. INTRODUCTION...
Risk Management?
______________________________________
Example 1: Let be the value of Stock . Let . W 3 V A W A " A !
3 3 3 3 3
3" 3"
8 8
_ _
"5% Value-at-Risk" of a Portfolio is defined as follows:
T<V Z EV !!&
Gaussian Copulas have been used to model dependence between W W
" 8
Example 2: Four satellite are needed in orbit to make three dimensional
observations of the earth magnetosphere. The orbit each selected so that each
islocated at the corner point of a predetermined tethahedron, when crossing
regions of interest within the magnetosphere.
1. INTRODUCTION...
Risk Management?
______________________________________
Lifetime of the indivdual satelites are random but dependent. Let be the \
%W
lifetime of the system if four satellites are put into orbit and if a fifth \
&W
redundant satelite if put into orbit. Copulas can be used to study the difference
between and . Is reliability improvement of sending a fifth satelite into \ \
%W &W
orbit worth its cost when taking dependence into account?
\ Q38\ \ \ \
%W " # $ %
\ Q+B Q38\ \ \ \ Q38\ \ \ \
&W " # $ % " # $ &
Q38\ \ \ \ Q38\ \ \ \
" # % & " $ % &
Q38\ \ \ \
# $ % &

1. INTRODUCTION...
Risk Management?
______________________________________
Example 3: Consider the following project network representating the constuction
of a ship. The activity completion times are dependent random variables. Copulas
can be used to construct the dependence between these random variables and
evaluate the project completion time distribution.
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11 11 10 10 99 77
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OUTLINE
______________________________________
1. INTRODUCTION
2. COPULA CONSTRUCTION...
Archimedean Copulas
______________________________________
Genest and Mackay (1986) used for copula an algabraic method
construction.
, with - : : ! " ! " ! a convex decreasing function The generator
function.
They possess : joint cdf and probability density function (pdf)
GB Cl "
B C B C !
!
:
: : : : :
_
"
elsewhere
-B Cl #
GB C B C
GB C
:
: : :
:
'' ' '
'
$
OUTLINE
______________________________________
1. INTRODUCTION
3. ARCHIMEDEAN EXAMPLES...
Clayton Copula
______________________________________
Generator Function:
: : > > " = " =
" "
0
Cumulative Distribution Function:
GB Cl B C " !

"

Probability Density Function:

-B Cl
" BC
BC B C BC

"

"#
0
Clayton Copula
______________________________________
T<] !&l\ !& !(& "*"&
0 1
0
1
0
1
0
1
0.00
1.00
2.00
3.00
4.00
5.00
Joint Probability Density Function Contour Plot PDF
Gumbel Copula
______________________________________
Generator Function:
: : > > = /B: = " ln
" "

GB Cl IB: B C " _ _ ln ln

"

-B Cl IB: B C
B C
B C
B C " B C "

_ _
_ _
ln ln
ln ln
ln ln ln ln

"
" "
# # " #
Gumbel Copula
______________________________________
T<] !&l\ !& !(& "**(
0
1
0
1
0.00
1.00
2.00
3.00
4.00
5.00
0 1
0
1

Frank Copula
______________________________________
Generator Function:
: : > = " / / " !
/ "
/ "
ln ln

>
" " =
"
ln_ _ " !
/ "/ "
/ "
B B

-B Cl "
/ / / "/ "
/ " / "
/ "/ " / "/ "
/ " / "
" " !

B C B B

"
B B B B

"

_ _
_ _
_ _
Frank Copula
______________________________________
T<] !&l\ !& !(& %)(&
0
1
0
1
0.00
1.00
2.00
3.00
4.00
5.00
0 1
0
1

OUTLINE
______________________________________

1. INTRODUCTION
Genealized Diagonal Band
______________________________________
Cooke and Waij (1986) used for copula construction a geometric method
0
1
0
1
0.00
1.00
2.00
3.00
4.00
x
y
(0, 1)
(1, )
DB
2
DB
1
DB
3
A
B
y
(0, 1)
(1, 2)
(0, 1)
(1, 0)
(0, 0)
(1, 1)
0
1
0
1
0.00
1.00
2.00
3.00
4.00
x
y
(0, 1)
(1, )
DB
2
DB
1
DB
3
A
B
y
(0, 1)
(1, 2)
(0, 1)
(1, 0)
(0, 0)
(1, 1)
A: Gray area support of a copula comprised HF )
of sub-areas B: Example of a copula. HF 3 " # $ HF!&
3
Diagonal Band Copula
______________________________________
Diagonal Band (DB) copula possess pdf:
GB Cl $
"" B C HF HF
"#" B C HF
!
)
)
)
_
_
_
" $
#
elsewhere
, Analagous to Archimedean copula Bojarski (2001) generalized copula via HF ) a
generator function | . 0 )
Generator function | is a with support . 0 ) ) symmetric pdf " " )
Lewandowski (2005) showed that Bojarski's (2001) GDB Copulae are
equivalent to Fergusons (1995) family of copulae with joint pdf:
-B C 1lB Cl 1" l" B Cl %
"
#
, 1 ! " pdf on
Generalized DB Copula
______________________________________
For sampling efficiency of generator would be desirable. inverse cdf 0 l )
Consider Van Dorp and Kotz's (2003) symmetric Two-Sided (TS) pdf's
0 Dl: l
"
#
:D "l " D !
:" Dl ! D "
{
, for
, for
G
G
G
_
&
that too uses the generating pdf concept. Pdf has support :D :D ! "
The associated with inverse cdf (or quantile function) %
J ?l: l
! ?
? "
"
"
#
"
#
{
, for
, for
G
G
G
_
T #?l "
" T # #?l
'
"
"
where is the quantile function of T l
"
< : l G
4. CONSTRUCTION...
GDB Copula with TS Gen. PDF
______________________________________
Bivariate pdf is constructed where and 1B C \ Y! " the conditional
pdf 1ClB has the following form
1ClB ( : l l: l G G 0B C B " C B " , ,
From , and it follows that: \ Y! " ( TS framework pdf %
1B Cl )
: l
"
#
:" l
:" l
G
G
G
_
B C " B C !
B C ! B C "
From , a bivariate pdf | is constucted on the unit square ) -B C : l G
! " 1B Cl
#
of outside by folding back the probability masses : l G
the unit square onto it, ! "
#
using "folding" lines and . C " C !
4. CONSTRUCTION...
______________________________________
0
1 0
1
0.00
1.00
2.00 x
y
1
1
x y = 1
x y = 1
B
x y = 0
(0,0)
(1,1)
(1,0)
(0,1)
C
2
A
4
A
3
A
1
A
x + y = 1
x + y = 0
x + y = 2
x
y
1
A
3
A
2
A
4
A
A: pdf B: Areas 1B C ) E 3 " %
3
C: pdf with on . -B Cl "! :D #D ! " : l G
4. CONSTRUCTION...
______________________________________
Relationship between and -B Cl 1B Cl : l : l G G in 8
-B Cl
1B Cl 1B Cl
1B Cl 1B # Cl
: l *
: l : l
: l : l
G
G G
G G
_
! B C "
" B C #
,
.
Combining with * ) now yields
-B Cl
"
#

"
"
: l
: l :" l
: l :" l
: l :" l
: l
G
G G
G G
G G
G
_
_
B C B C B C E
B C B C B C E
B C " B C B C E
B C "
"
#
$
,
,
,
:" l B C B C E G
%
"!
Note in "! -C B -B C \ Y! " ] Y! " . Hence,
4. CONSTRUCTION...
Joint CDF
______________________________________
Pdf of GDB copula with TS pdf with generating pdf :DlG
-B Cl
"
#

"
"
: l
: l :" l
: l :" l
: l :" l
: l
G
G G
G G
G G
G
_
_
B C B C B C E
B C B C B C E
B C " B C B C E
B C "
"
#
$
,
,
,
:" l B C B C E G
%
Cdf of GDB copula with TS gen. pdf :DlG and cdf TDl G follows as:
GB Cl

: l
B TDl .D
C TDl .D
B TDl .D
C
G
G
G
G
_
_
"
# "
"
# "
"
#
BC
B
"
BC
BC
#
C"
BC
$
" C
"
B
"
B C E
B C E
B C E
,
,
,
TDl .D
"
#
BC"
BC
%
"
G
""
B C E
OUTLINE
______________________________________
1. INTRODUCTION

5. GDB EXAMPLES WITH TS GEN. PDF...
Triangular PDF
______________________________________
Substitution of generating pdf :D #D with support in yields ! " "!
-B C #
" "

_
C B C E B B C E
B B C E C B C E
" #
$ %
, ,
,
0
1 0
1
0.00
1.00
2.00
A
B
1.0
0.5
1.0 0.5
0.0
2.0
1.5
1.5
2.0
1.0 0.5 1.5
0.0
0.5
1.0
1.5
x
y
1
A
3
A
2
A
4
A
1
A
3
A
2
A
4
A
A: Copula density ; B: Density contour plot -B C
Triangular PDF
______________________________________
Substitution of pdf :D #D "" in and yields: generating cdf TD D
#
GB C
"
$
B $BC 'BC
C $B C 'BC
C $C $CB " $B $B "
B $B $BC " $C $C "
_
_
$ #
$ #
$ # # #
$ # # #
B C E
B C E
B C E
B C E
"
#
$
%
,
,
,
0
1
0
1
0.00
0.20
0.40
0.60
0.80
1.00
x
y
0
0.5
1
1.5
2
0 0.2 0.4 0.6 0.8 1
z
G
e
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P
D
F

o
f

T
S

F
r
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Graph of joint triangular copula cdf GB C given above
Slope PDF
______________________________________
:Dl # D ! # # "
In figure below: 0.583 T<] !&l\ !& "&
0
1
0
1
0.00
1.00
2.00
3.00
4.00
0
0.5
1
1.5
2
2.5
3
3.5
4
0 0.2 0.4 0.6 0.8 1
z
S
l
o
p
e

P
D
F
A B
A: Slope generating pdf; B: GDB Copula with TS Gen. PDF in A
Power PDF
______________________________________
:Dl8 8D 8 !
8"
In figure below: 0.750, T<] !&l\ !& 8 $
0
1
0
1
0.00
1.00
2.00
3.00
4.00
0
0.5
1
1.5
2
2.5
3
3.5
4
0 0.2 0.4 0.6 0.8 1
z
P
o
w
e
r

P
D
F
C D
C: Power generating pdf; D: GDB Copula with TS Gen. PDF in A
Ogive PDF
______________________________________
:Dl7 # 7" D 7D 7 !
7#
$7%
( ) .
7
7"
In figure below: 0.750, T<] !&l\ !& 7 %*"'
0
1
0
1
0.00
1.00
2.00
3.00
4.00
0
0.5
1
1.5
2
2.5
3
3.5
4
0 0.2 0.4 0.6 0.8 1
z
O
g
i
v
e

P
D
F
E F
E: Ogive generating pdf; F: GDB Copula with TS Gen. PDF in A
Uniform PDF " )
______________________________________
:Dl D " ! "
"
"
) ) )
)
In figure below: 0.750, T<] !&l\ !& !& )
0
1
0
1
0.00
1.00
2.00
3.00
4.00
0
0.5
1
1.5
2
2.5
3
3.5
4
0 0.2 0.4 0.6 0.8 1
z
U
n
i
f
o
r
m

P
D
F
G H
G: Uniform gen pdf; H: " ) GDB Copula with TS Gen. PDF in A
Beta PDF
______________________________________
:Dl+ , B " B
+ ,
+ ,
>
> >
+" ,"
, , + ! , !
In figure below: 0. 0, T<] !&l\ !& & + , &
0
1
0
1
0.00
1.00
2.00
3.00
4.00
0
0.5
1
1.5
2
2.5
3
3.5
4
0 0.2 0.4 0.6 0.8 1
z
S
l
o
p
e

P
D
F
I
J
G: Beta generating pdf; H: GDB Copula with TS Gen. PDF in A
OUTLINE
______________________________________
1. INTRODUCTION

7. SAMPLING PROCEDURE...
Archimedean Copula
______________________________________
- : ! " ! The archimedean copula generator function.
Let be the cdf of a random variable such that K ^
_
!
=> "
K>/ .> = :
In other words, is the Laplace transform of the cdf :
"
= K
Clayton Copula: :
" " "
= " = ^ K+77+ "
0
Gumbel Copula: : #
" " "
= /B: = " ^ W>+,6/ " !
. # cos
1
#
Frank Copula: :
" " =
= " / / " ! ln

,
T<^ 5 " " /
)
5
5
"
ln ) )
Archimedean Copula
______________________________________
Algorithm (Marshall and Olkin, 1988):
Step 1: Sample from a uniform random variable on , ? Y ! "
Step 2: Sample from a uniform random variable on , @ Z ! "
Step 3: Sample from , D K l
Step 4: Evaluate , ?
ln?
D
Step 5: Evaluate , @
ln@
D
Step 6: B ? :
"
Step 7: . C @ :
"
OUTLINE
______________________________________
1. INTRODUCTION

GDB Copula
______________________________________
x
y
1
y = 1
1. Sample x in [0,1]
2. Sample z in [-1,1]
3. y = z + x
4. If y < 0 then y = y
5. If y > 1 Then y =1( y1)
ALGORITHM:
z
x
y = x
y
y
y = 1
GDB Copula
______________________________________
random variable with ^ symmetric Two-Sided (TS) pdf
0 Dl: l
"
#
:D "l " D !
:" Dl ! D "
{
, for
, for
G
G
G
_
&
where is a generating pdf with support :D ! "
Step 1: Sample from a uniform random variable on . B \ ! "
Step 2: Sample from a uniform random variable on . ? Y ! "
Step 3: If then else ? D T #? " D " T # #
"
#
" "
?
Step 4: C D B
Step 5: If then C ! C C
Step 6: If then C " C " C "
GDB Copula
______________________________________
For the generating densities herein we have for arbitrary quantile level
; ! ":
T
:Dl "
; :Dl8
; :Dl7
" ;
"
# # % ";
# "
"8
#7" #7"
7 7 7
#
$7%
#7#
;l <
_
_
_ _
__ _

_
#

) ) :Dl )
One could favor the power pdf and uniform pdf's due to least number of
operations.
8. COPULAE...
Selected References
______________________________________
Cooke, R.M. and Waij, R. 1986 Monte carlo sampling for generalized knowledge dependence, with
application to human reliability. , 6 (3), pp. 335-343. Risk Analysis
Genest, C. and Mackay, J. (1986). The joy of copulas, bivariate distributions with uniform marginals. The
American Statistician, 40 (4), pp. 280-283.
Ferguson, T.F. (1995). A class of symmetric bivariate uniform distributions. , 36 (1), pp. Statistical Papers
31-40.
S Kotz and J R van Dorp (2009), Generalized Diagonal Band Copulas with Two-Sided Generating
Densities, , published online before print November 25, Decision Analysis
DOI:10.1287/deca.1090.0162.
Marshall, A W. and I. Olkin (1988) Families of multivariate distributions. J ournal of the American Statistical
Association, 83, 834841.
McNeil, A., R. Frey, and P. Embrechts (2005). . Quantitative Risk Management: Concepts,Techniques and Tools
Princeton University Press.
Nelsen, R.B. (1999). . Springer, New York. An Introduction to Copulas
Sklar, A. (1959). Fonctions de rpartition n dimensions et leurs marges. 8, Publ. Inst. Statist. Univ. Paris,
pp. 229-231.
Van Dorp, J.R and Kotz, S. (2003). Generalizations of two sided power distributions and their
convolution. , 32 (9), pp. 1703 - 1723. Communications in Statistics: Theory and Methods

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EMSE 280 - Copula Lecture: Part 1 J.R. van Dorp; www.seas.gwu.

Probability Density Function:

Cumulative Distribution Function:

Probability Density Function:

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