Efficient estimation of a semiparametric dynamic copula model

A new semiparametric dynamic copula model is proposed where the marginals are specified as parametric GARCH-type processes, and the dependence parameter of the copula is allowed to change over time in a nonparametric way. A straightforward two-stage estimation method is given by local maximum likelihood for the dependence parameter, conditional on consistent first stage estimates of the marginals. First, the properties of the estimator are characterized in terms of bias and variance and the bandwidth selection problem is discussed. The proposed estimator attains the semiparametric efficiency bound and its superiority is demonstrated through simulations. Finally, the wide applicability of the model in financial time series is illustrated, and it is compared with traditional models based on conditional correlations. (C) 2010 Elsevier B.V. All rights reserved.