Using Copula Functions in Bayesian Analysis: A Comparison of the Lognormal Conjugate

Bayesian techniques have been applied to analyze sequential investment decisions in the capital budgeting literature. This article introduces copula-based Bayesian analysis as an alternative to the traditional approach where conjugate relationships do not exist. Using a numerical example, we illustrate the steps involved in the copula-based Bayesian approach. Graphical techniques for selecting an appropriate copula are also discussed. The unique ability of copulas to model nonlinear dependence rationalizes the use of copula functions as an alternative technique.