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Nonlinear Bivariate Comovements of Asset Prices: Theory and Tests

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  • Marco Corazza

    ()
    (Department of Applied Mathematics, University of Venice)

  • A.G. Malliaris

    ()
    (Department of Economics, Loyola University of Chicago)

  • Elisa Scalco

    (Department of Applied Mathematics, University of Venice)

Abstract

Comovements among asset prices have received a lot of attention for several reasons. For example, comovements are important in cross-hedging and cross-speculation; they determine capital allocation both domestically and in international meanÐvariance portfolios and also, they are useful in investigating the extent of integration among financial markets. In this paper we propose a new methodology for the nonÐlinear modelling of bivariate comovements. Our approach extends the ones presented in the recent literature. In fact, our methodology outlined in three steps, allows the evaluation and the statistical testing of non-linearly driven comovements between two given random variables. Moreover, when such a bivariate dependence relationship is detected, our approach solves for a polynomial approximation. We illustrate our threeÐsteps methodology to the time series of energy related asset prices. Finally, we exploit this dependence relationship and its polynomial approximation to obtain analytical approximations of the Greeks for the European call and put options in terms of an asset whose price comoves with the price of the underlying asset.

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Bibliographic Info

Paper provided by Department of Applied Mathematics, Università Ca' Foscari Venezia in its series Working Papers with number 137.

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Length: 26 pages
Date of creation: Sep 2006
Date of revision:
Handle: RePEc:vnm:wpaper:137

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Keywords: Comovement; asset prices; bivariate dependence; non-linearity; t-test; polynomial approximation; energy asset; (vanilla) European call and put options; crossÐGreeks.;

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