A study of the correlation of extreme returns between Taiwanese and international equity markets
Authors: Jian-Hsin Chou, Shu-Min Chan
Journal: Chiao Da Management Review. Jun. 2008, 28(1): 205-250.
Keywords: Extreme value theory; Extreme-returns correlation; Multivariate normal distribution
Abstract:
In today’s globalized investing environment, the government sets overseas-investing policy, and domestic investors decide how to diversify
their portfolios, by examining the correlation among international equity markets. This paper uses the extreme value theory proposed by Longin
and Solnik (2001) to investigate the similarities between the international and Taiwan stock markets. Five national stock markets (those of
Taiwan, the United States, Japan, Hong Kong, Singapore and South Korea) are used to test their extreme-returns relationships. The empirical
results show that, in monthly data, the correlation of extreme negative returns among the five countries is greater than the correlation of
extreme positive returns. When extreme returns are negative, the stock price index correlation rises when the absolute value of the correlation
threshold increases; when extreme returns are positive, the stock price index correlation drops when the threshold value decreases. On the
contrary, in weekly data, the empirical results indicate that the correlation of extreme returns among the five countries decreases regardless
of whether the returns are negative or positive. Finally, if we assume that the sample data are in a multivariate normal distribution, no
matter whether the data is weekly or monthly, or the returns are negative or positive, when the absolute value of the correlation threshold
increases, the correlations tend to decrease.