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Correlation vs. Causality in Stock Market Comovement

  • Enzo Weber

This paper seeks to disentangle the sources of correlations between high-, mid- and lowcap stock indexes from the German prime standard. In principle, such comovement can arise from direct spillover between the variables or due to common factors. By standard means, these different components are obviously not identifiable. As a solution, the underlying study proposes specifying ARCH-type models for both the idiosyncratic innovations and a common factor, so that the model structure can be identified through heteroscedasticity. The seemingly surprising result that smaller caps have higher influence than larger ones is explained by asymmetric information processing in financial markets. Broad macroeconomic information is shown to enter the common factor rather than the segment-specific shocks.

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Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2007-064.

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Length: 24 pages
Date of creation: Dec 2007
Date of revision:
Handle: RePEc:hum:wpaper:sfb649dp2007-064
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  9. Roberto Rigobon, 2003. "Identification Through Heteroskedasticity," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 777-792, November.
  10. Ross, Stephen A, 1989. " Information and Volatility: The No-Arbitrage Martingale Approach to Timing and Resolution Irrelevancy," Journal of Finance, American Finance Association, vol. 44(1), pages 1-17, March.
  11. Ernst R. Berndt & Bronwyn H. Hall & Robert E. Hall & Jerry A. Hausman, 1974. "Estimation and Inference in Nonlinear Structural Models," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 3, number 4, pages 653-665 National Bureau of Economic Research, Inc.
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