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Tail-Dependence in Stock-Return Pairs

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Author Info
Fortin, Ines (Department of Economics and Finance, Institute for Advanced Studies, Vienna)
Kuzmics, Christoph (Faculty of Economics and Politics, University of Cambridge)

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Abstract

The empirical joint distribution of return-pairs on stock indices displays high tail-dependence in the lower tail and low tail-dependence in the upper tail. The presence of tail-dependence is not compatible with the assumption of (conditional) joint normality. The presence of asymmetric-tail dependence is not compatible with the assumption of a joint student-t distribution. A general test for one dependence structure versus another via the profile-likelihood is described and employed in a bivariate GARCH model, where the joint distribution of the disturbances is split into its marginals and its copula. The copula used is such that it allows for the presence of lower tail-dependence and for asymmetric tail-dependence, and that it encompasses the normal or t-copula. The model is estimated using bivariate data on a set of European stock indices. We find that the assumption of normal or student-t dependence is easily rejected in favour of an asymmetrically tail-dependent distribution.

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File URL: http://www.ihs.ac.at/publications/eco/es-126.pdf
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File Function: First version, 2002
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Publisher Info
Paper provided by Institute for Advanced Studies in its series Economics Series with number 126.

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Length: 31 pages
Date of creation: Nov 2002
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Handle: RePEc:ihs:ihsesp:126

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Related research
Keywords: Value-at-Risk; Copula; Non-normal bivariate GARCH; Asymmetric dependence; Profile likelihood-ratio test;

Find related papers by JEL classification:
C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Hypothesis Testing
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation and Testing
C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Mico Loretan & William B. English, 2000. "Evaluating "correlation breakdowns" during periods of market volatility," International Finance Discussion Papers 658, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  2. Andrew J. Patton, 2001. "Modelling Time-Varying Exchange Rate Dependence Using the Conditional Copula," University of California at San Diego, Economics Working Paper Series 2001-09, Department of Economics, UC San Diego. [Downloadable!]
  3. François Longin, 2001. "Extreme Correlation of International Equity Markets," Journal of Finance, American Finance Association, vol. 56(2), pages 649-676, 04. [Downloadable!] (restricted)
  4. Bollerslev, Tim, 1987. "A Conditionally Heteroskedastic Time Series Model for Speculative Prices and Rates of Return," The Review of Economics and Statistics, MIT Press, vol. 69(3), pages 542-47, August. [Downloadable!] (restricted)
  5. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April. [Downloadable!] (restricted)
  6. McNeil, Alexander J. & Frey, Rudiger, 2000. "Estimation of tail-related risk measures for heteroscedastic financial time series: an extreme value approach," Journal of Empirical Finance, Elsevier, vol. 7(3-4), pages 271-300, November. [Downloadable!] (restricted)
  7. A. Sancetta & Satchell, S.E., 2001. "Bernstein Approximations to the Copula Function and Portfolio Optimization," Cambridge Working Papers in Economics 0105, Faculty of Economics, University of Cambridge. [Downloadable!]
  8. Kanas, Angelos, 1998. "Volatility Spillovers across Equity Markets: European Evidence," Applied Financial Economics, Taylor and Francis Journals, vol. 8(3), pages 245-56, June. [Downloadable!] (restricted)
  9. Longin, Francois & Solnik, Bruno, 1995. "Is the correlation in international equity returns constant: 1960-1990?," Journal of International Money and Finance, Elsevier, vol. 14(1), pages 3-26, February. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Klaus Abberger, 2005. "A simple graphical method to explore tail-dependence in stock-return pairs," Applied Financial Economics, Taylor and Francis Journals, vol. 15(1), pages 43-51, January. [Downloadable!] (restricted)
    Other versions:
  2. Sancetta, A., 2005. "Copula Based Monte Carlo Integration in Financial Problems," Cambridge Working Papers in Economics 0506, Faculty of Economics, University of Cambridge. [Downloadable!]
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