Estimation of Copula Models with Discrete Margins via Bayesian Data Augmentation

Michael S. Smith, Melbourne Business School
Mohamad A. Khaled, University of Sydney

Abstract

Estimation of copula models with discrete margins is known to be difficult beyond the bivariate case. We show how this can be achieved by augmenting the likelihood with latent variables, and computing inference using the resulting augmented posterior. To evaluate this we propose two efficient Markov chain Monte Carlo sampling schemes. One generates the latent variables as a block using a Metropolis-Hasting step with a proposal that is close to its target distribution, the other generates them one at a time. Our method applies to all parametric copulas where the conditional copula functions can be evaluated, not just elliptical copulas as in previous Bayesian work. Moreover, the copula parameters can be estimated joint with any marginal parameters. We establish the effectiveness of the estimation method by modeling consumer behavior in online retail using Archimedean and Gaussian copulas. The example shows that elliptical copulas can be poor at modeling dependence in discrete data, just as they can be in the continuous case. To demonstrate the potential in higher dimensions we estimate 16 dimensional D-vine copulas for a longitudinal model of usage of a bicycle path in the city of Melbourne, Australia. The estimates reveal an interesting serial dependence structure that can be represented in a parsimonious fashion using Bayesian selection of independence pair-copula components. Finally, we extend our results and method to the case where some margins are discrete and others continuous.