Beyond Correlation: Extreme Co-Movements between Financial Assets

48 Pages Posted: 15 Jul 2002

See all articles by Assaf Zeevi

Assaf Zeevi

Columbia Business School - Decision Risk and Operations

Roy Mashal

Lehman Brothers, New York

Date Written: October 14, 2002

Abstract

This paper investigates the potential for extreme co-movements between financial assets by directly testing the underlying dependence structure. In particular, a t-dependence structure, derived from the Student t-distribution, is used as a proxy to test for this extremal behavior. Tests in three different markets (equities, currencies, and commodities) indicate that extreme co-movements are statistically significant. Moreover, the "correlation-based" Gaussian dependence structure, underlying the multivariate Normal distribution, is rejected with negligible error probability when tested against the t-dependence alternative. The economic significance of these results is illustrated via three examples: co-movements across the G5 equity markets; portfolio value-at-risk calculations; and, pricing credit derivatives.

This paper investigates the potential for extreme co-movements between financial assets by directly testing the underlying dependence structure. In particular, a t-dependence structure, derived from the Student t-distribution, is used as a proxy to test for this extremal behavior. Using likelihood ratio-based methods, we show that the presence of extreme co-movements is statistically significant in three asset markets (equities, currencies, and commodities), as well as across international (G5) equity markets. In addition, this likelihood ratio test indicates that the "correlation-based" Gaussian dependence structure is not supported on the basis of observed asset co-movements. The economic significance and consequences of these results are illustrated via several examples.

Keywords: asset returns, extreme co-movements, copulas, dependence modeling, hypothesis testing, international markets, pseudo-likelihood, portfolio models, risk management

JEL Classification: C12, C15, C52, G11

Suggested Citation

Zeevi, Assaf and Mashal, Roy, Beyond Correlation: Extreme Co-Movements between Financial Assets (October 14, 2002). Available at SSRN: https://ssrn.com/abstract=317122 or http://dx.doi.org/10.2139/ssrn.317122

Assaf Zeevi

Columbia Business School - Decision Risk and Operations ( email )

New York, NY
United States
212-854-9678 (Phone)
212-316-9180 (Fax)

HOME PAGE: http://www.gsb.columbia.edu/faculty/azeevi/

Roy Mashal (Contact Author)

Lehman Brothers, New York ( email )

745 Seventh Avenue
New York, NY 10019
United States

HOME PAGE: http://www.faculty.idc.ac.il/roy/

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