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Dependence Structure and Extreme Comovements in International Equity and Bond Markets

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  • René Garcia
  • Georges Tsafack

Abstract

Common negative extreme variations in returns are prevalent in international equity markets. This has been widely documented with statistical tools such as exceedance correlation, extreme value theory, and Gaussian bivariate GARCH or regime-switching models. We point to limits of these tools to characterize extreme dependence and propose an alternative regime-switching copula model that includes one normal regime in which dependence is symmetric and a second regime characterized by asymmetric dependence. Moreover, to fully appreciate the potential effects of this asymmetric dependence in terms of portfolio diversification, we apply this model to international equity and bond markets, to allow for inter-market movements. Empirically, we find that dependence between international assets of the same type is strong in both regimes, especially in the asymmetric one, but weak between equities and bonds, even in the same country. We study analytically how and when asymmetric dependence may amplify empirically documented phenomena such as flight to safety and home bias in portfolio allocation. Les écarts de rendement négatifs extrêmes communs existent dans les marchés boursiers internationaux. Ce phénomène a été largement démontré par des outils statistiques, tels que la corrélation des dépassements, la théorie des valeurs extrêmes et les modèles GARCH bivarié en langage Gauss ou avec changement de régime. Nous signalons les limites de ces outils pour caractériser la dépendance extrême et proposons un modèle de copules avec changement de régime, comprenant un régime normal dans lequel la dépendance est symétrique et un second régime caractérisé par une dépendance asymétrique. De plus, afin de saisir pleinement l’incidence potentielle de cette dépendance asymétrique en termes de diversification du portefeuille, nous appliquons ce modèle aux marchés internationaux des actions et des obligations, afin de permettre les mouvements entre les marchés. D’un point de vue empirique, nous constatons une forte dépendance entre les actifs internationaux de même type dans les deux régimes, surtout dans le régime asymétrique, et une faible dépendance entre les actions et les obligations, bien qu’il soit question d’un même pays. Nous procédons à un examen analytique afin de déterminer quand et comment la dépendance asymétrique peut, lors de la répartition du portefeuille, amplifier les phénomènes suivants établis empiriquement : fuite vers la sécurité et surinvestissement dans des sociétés proches du domicile.

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Paper provided by CIRANO in its series CIRANO Working Papers with number 2009s-21.

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Date of creation: 01 May 2009
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Handle: RePEc:cir:cirwor:2009s-21

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Keywords: asymmetric correlation; asymmetric dependence; copula; tail dependence; GARCH; regime switching; home bias; flight to safety; corrélation asymétrique; dépendance asymétrique; copules; dépendance dans les queues; GARCH; changement de régime; surinvestissement dans des sociétés proches du domicile; fuite vers la sécurité;

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