Factor copula models for multivariate data

Abstract

General conditional independence models for d observed variables, in terms of p latent variables, are presented in terms of bivariate copulas that link observed data to latent variables. The representation is called a factor copula model and the classical multivariate normal model with a correlation matrix having a factor structure is a special case. Dependence and tail properties of the model are obtained. The factor copula model can handle multivariate data with tail dependence and tail asymmetry, properties that the multivariate normal copula does not possess. It is a good choice for modeling high-dimensional data as a parametric form can be specified to have O(d) dependence parameters instead of O(d2) parameters. Data examples show that, based on the Akaike information criterion, the factor copula model provides a good fit to financial return data, in comparison with related truncated vine copula models.