Dynamic Conditional Correlations between Chinese Sector Returns and the S&P500 Index: An Interpretation Based on Investment Shocks
Posted: 23 Aug 2016 Last revised: 17 Oct 2017
Date Written: September 11, 2016
This paper examines the dynamic conditional correlations between the Chinese sector returns and the S&P500 index returns and offers an interpretation for the heterogeneity of sector-level return correlations. Using a sample of 12 Chinese sectors for the period of 2006-2014, we first observe that their conditional correlations with the S&P500 index vary significantly across sectors and across the two crises, namely, the 2008-2009 Global Financial Crisis and the 2010-2011 European Debt Crisis. We then interpret the heterogeneity of sector-level conditional correlations as arising from their heterogeneous sensitivities to investment shocks. We finally verify our interpretation. Our main finding is that sector-level investment opportunities, as proxied by book-to-market ratio, capital expenditure, long-term debt ratio, growth rate of industry size, and Tobin's Q, are significantly associated with the magnitude of their dynamic conditional correlations. This paper thereby advances our understanding of sectoral heterogeneities from the perspective of their responses to an outer investment shock.
Keywords: Dynamic Conditional Correlation, Sector Portfolios, Investment-Specific Shock, Growth Opportunity
JEL Classification: G12, G15, C32
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