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Time-series and cross-sectional excess comovement in stock indexes

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  • Kallberg, Jarl
  • Pasquariello, Paolo

Abstract

This paper is an empirical investigation of the excess comovement among 82 industry indexes in the U.S. stock market between January 5, 1976 and December 31, 2001. We define excess comovement as the covariation between two assets beyond what can be explained by fundamental factors. In our analysis, the fundamental factors are sector groupings and the three Fama-French factors. We then estimate residuals of joint (FGLS) rolling regressions of these fundamentals on industry returns. Finally, we compute excess comovement as the mean of square unconditional, statistically significant correlations of these residuals. We show that excess comovement is high (about 0.07, i.e., equivalent to an average absolute correlation of 0.26), statistically significant, and represents an economically significant portion (almost 30%) of the average gross square return correlation. Excess comovement is also uniformly significant across industries and over time and only weakly asymmetric, i.e., not significantly different in rising or falling markets. We explain more than 23% of this market-wide (and up to 73% of sector-wide) excess square correlation by its positive relation to proxies for information heterogeneity and U.S. monetary and real conditions, and its negative relation to market volatility and the level of the short-term interest rate. This evidence is consistent with the implications of portfolio rebalancing and product market theories of financial contagion, but offers little or no support for the correlated liquidity shock channel.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Empirical Finance.

Volume (Year): 15 (2008)
Issue (Month): 3 (June)
Pages: 481-502

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Handle: RePEc:eee:empfin:v:15:y:2008:i:3:p:481-502

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Web page: http://www.elsevier.com/locate/jempfin

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Citations

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Cited by:
  1. Julien Idier, 2011. "Long-term vs. short-term comovements in stock markets: the use of Markov-switching multifractal models," The European Journal of Finance, Taylor & Francis Journals, vol. 17(1), pages 27-48.
  2. Bekaert, Geert & Hodrick, Robert J. & Zhang, Xiaoyan, 2005. "International Stock Return Comovements," Working Papers 06-3, University of Pennsylvania, Wharton School, Weiss Center.
  3. Yannick Le Pen & Benoît Sévi, 2013. "Futures Trading and the Excess Comovement of Commodity Prices," Working Papers halshs-00793724, HAL.
  4. Choe, Kwang-il & Choi, Pilsun & Nam, Kiseok & Vahid, Farshid, 2012. "Testing financial contagion on heteroskedastic asset returns in time-varying conditional correlation," Pacific-Basin Finance Journal, Elsevier, vol. 20(2), pages 271-291.
  5. repec:ipg:wpaper:19 is not listed on IDEAS
  6. Anufriev, Mikhail & Bottazzi, Giulio & Marsili, Matteo & Pin, Paolo, 2012. "Excess covariance and dynamic instability in a multi-asset model," Journal of Economic Dynamics and Control, Elsevier, vol. 36(8), pages 1142-1161.
  7. Paolo Pasquariello & Clara Vega, 2007. "Informed and Strategic Order Flow in the Bond Markets," Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 1975-2019, November.
  8. Pasquariello, Paolo & Vega, Clara, 2009. "The on-the-run liquidity phenomenon," Journal of Financial Economics, Elsevier, vol. 92(1), pages 1-24, April.
  9. Ocran, Mathew & Mlambo, Chipo, 2009. "Excess co-movement in asset prices: The case of South Africa," MPRA Paper 24277, University Library of Munich, Germany.
  10. Mondria, Jordi, 2010. "Portfolio choice, attention allocation, and price comovement," Journal of Economic Theory, Elsevier, vol. 145(5), pages 1837-1864, September.
  11. Krishnan, C.N.V. & Petkova, Ralitsa & Ritchken, Peter, 2009. "Correlation risk," Journal of Empirical Finance, Elsevier, vol. 16(3), pages 353-367, June.
  12. Sévi, Benoît & Le Pen, Yannick & Chevallier, Julien & Bunn, Derek, 2013. "Fundamental and Financial Influences on the Co-movement of Oil and Gas Prices," Economics Papers from University Paris Dauphine 123456789/11692, Paris Dauphine University.
  13. Kühl, Michael, 2009. "Excess comovements between the Euro/US dollar and British pound/US dollar exchange rates," Center for European, Governance and Economic Development Research Discussion Papers 89, University of Goettingen, Department of Economics.
  14. Vozlyublennaia, Nadia & Meshcheryakov, Artem, 2014. "Dynamic correlation structure and security risk," Journal of Economics and Business, Elsevier, vol. 73(C), pages 48-64.
  15. Le Pen, Yannick & Sévi, Benoît, 2010. "Revisiting the excess co-movements of commodity prices in a data-rich environment," Economics Papers from University Paris Dauphine 123456789/6800, Paris Dauphine University.

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