An empirical analysis of the dependence structure of international equity and bond markets using regime-switching copula model

Yuko Otani, Junichi Imai

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1 Citation (Scopus)

Abstract

In this paper, we perform an empirical analysis of the dependence structure of international equity and bond markets using the regime-switching copula model. In equity markets, it is observed that negative returns are more strongly dependent than positive returns. This phenomenon is known as asymmetric dependence. The regime-switching copula model, which includes symmetric and asymmetric regimes, is suitable for describing asymmetry. We apply two kinds of flexible multivariate copulas, a skew t copula and a vine copula, to the asymmetric regime to deal with dependencies between two asset classes. In this paper, we analyze three country pairs: the United Kingdom and United States (UK-US), Japan-US, and Italy-US. We find three implications of our empirical analysis. First, highly dependent regimes are different according to the asset pairs. Second, the strength of the asymmetry of each country pair varies, and that of the Japan-US pair is weak. Third, the skew t copula is a better fit to the data, but is not flexible enough to capture extreme dependencies, while the vine copula fits well in spite of having fewer parameters, but cannot express the different extreme dependencies of each asset pair.

Original languageEnglish
Pages (from-to)191-205
Number of pages15
JournalIAENG International Journal of Applied Mathematics
Volume48
Issue number2
Publication statusPublished - 2018 May 28

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Regime-switching Model
Copula Models
Dependence Structure
Empirical Analysis
Equity
Copula
Japan
Skew
Asymmetry
Extremes
Dependent
Express
Market
Financial markets
Vary

Keywords

  • Asymmetry
  • Copulas
  • International market correlation
  • Regime-switching model

ASJC Scopus subject areas

  • Applied Mathematics

Cite this

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N2 - In this paper, we perform an empirical analysis of the dependence structure of international equity and bond markets using the regime-switching copula model. In equity markets, it is observed that negative returns are more strongly dependent than positive returns. This phenomenon is known as asymmetric dependence. The regime-switching copula model, which includes symmetric and asymmetric regimes, is suitable for describing asymmetry. We apply two kinds of flexible multivariate copulas, a skew t copula and a vine copula, to the asymmetric regime to deal with dependencies between two asset classes. In this paper, we analyze three country pairs: the United Kingdom and United States (UK-US), Japan-US, and Italy-US. We find three implications of our empirical analysis. First, highly dependent regimes are different according to the asset pairs. Second, the strength of the asymmetry of each country pair varies, and that of the Japan-US pair is weak. Third, the skew t copula is a better fit to the data, but is not flexible enough to capture extreme dependencies, while the vine copula fits well in spite of having fewer parameters, but cannot express the different extreme dependencies of each asset pair.

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