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Extreme Correlation of International Equity Markets

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  • Longin, François
  • Solnik, Bruno H
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    Abstract

    Testing the hypothesis that international equity market correlation increases in volatile times is a difficult exercise and misleading results have often been reported in the past because of a spurious relationship between correlation and volatility. This paper focuses on extreme correlation, that is to say the correlation between returns in either the negative or positive tail of the multivariate distribution. Using ‘extreme value theory’ to model the multivariate distribution tails, we derive the distribution of extreme correlation for a wide class of return distributions. Using monthly data on the five largest stock markets from 1958 to 1996, we reject the null hypothesis of multivariate normality for the negative tail, but not for the positive tail. We also find that correlation is not related to market volatility per se but to the market trend. Correlation increases in bear markets, but not in bull markets.

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    Bibliographic Info

    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2538.

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    Date of creation: Aug 2000
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    Handle: RePEc:cpr:ceprdp:2538

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    Related research

    Keywords: Correlation; Extreme Value Theory; International Equity Markets; Volatility;

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    References

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    1. de Haan, Laurens & Resnick, Sidney I. & Rootzén, Holger & de Vries, Casper G., 1989. "Extremal behaviour of solutions to a stochastic difference equation with applications to arch processes," Stochastic Processes and their Applications, Elsevier, Elsevier, vol. 32(2), pages 213-224, August.
    2. Lin, Wen-Ling & Engle, Robert F & Ito, Takatoshi, 1994. "Do Bulls and Bears Move across Borders? International Transmission of Stock Returns and Volatility," Review of Financial Studies, Society for Financial Studies, vol. 7(3), pages 507-38.
    3. Huisman, Ronald, et al, 2001. "Tail-Index Estimates in Small Samples," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 19(2), pages 208-16, April.
    4. Kristin Forbes & Roberto Rigobon, 1999. "No Contagion, Only Interdependence: Measuring Stock Market Co-movements," NBER Working Papers 7267, National Bureau of Economic Research, Inc.
    5. Dennis Jansen & Casper de Vries, 1988. "On the frequency of large stock returns: putting booms and busts into perspective," Working Papers 1989-006, Federal Reserve Bank of St. Louis.
    6. Ramchand, Latha & Susmel, Raul, 1998. "Volatility and cross correlation across major stock markets," Journal of Empirical Finance, Elsevier, Elsevier, vol. 5(4), pages 397-416, October.
    7. Kaplanis, Evi C., 1988. "Stability and forecasting of the comovement measures of international stock market returns," Journal of International Money and Finance, Elsevier, Elsevier, vol. 7(1), pages 63-75, March.
    8. Karolyi, G Andrew & Stulz, Rene M, 1996. " Why Do Markets Move Together? An Investigation of U.S.-Japan Stock Return Comovements," Journal of Finance, American Finance Association, American Finance Association, vol. 51(3), pages 951-86, July.
    9. Andrew Ang & Geert Bekaert, 1999. "International Asset Allocation with Time-Varying Correlations," NBER Working Papers 7056, National Bureau of Economic Research, Inc.
    10. Longin, Francois M, 1996. "The Asymptotic Distribution of Extreme Stock Market Returns," The Journal of Business, University of Chicago Press, vol. 69(3), pages 383-408, July.
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    Cited by:
    1. P. Hartmann & S. Straetmans & C.G. de Vries, 2001. "Asset Market Linkages in Crisis Periods," Tinbergen Institute Discussion Papers 01-071/2, Tinbergen Institute.
    2. Sakho, Yaye Seynabou, 2006. "Contagion and firms'internationalization in Latin America : evidence from Mexico, Brazil, and Chile," Policy Research Working Paper Series 4076, The World Bank.
    3. Morana, Claudio & Beltratti, Andrea, 2002. "The effects of the introduction of the euro on the volatility of European stock markets," Journal of Banking & Finance, Elsevier, vol. 26(10), pages 2047-2064, October.
    4. Andrea Beltratti & Claudio Morana, 2006. "Comovements in International Stock Markets," ICER Working Papers, ICER - International Centre for Economic Research 3-2006, ICER - International Centre for Economic Research.
    5. Claudio Morana, 2006. "International Stock Markets Comovements: the Role of Economic and Financial Integration," ICER Working Papers, ICER - International Centre for Economic Research 25-2006, ICER - International Centre for Economic Research.
    6. POON, Ser-Huang & ROCKINGER, Michael & TAWN, Jonathan, 2001. "New Extreme-Value Dependance Measures and Finance Applications," Les Cahiers de Recherche 719, HEC Paris.
    7. Gregory R. Duffee, 2001. "Asymmetric cross-sectional dispersion in stock returns: evidence and implications," Working Paper Series 2000-18, Federal Reserve Bank of San Francisco.

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