Dependence Structure of Market States
Journal of Statistical Mechanics: Theory and Experiment, 2015(8):P08012, 2015
19 Pages Posted: 7 Mar 2020
Date Written: February 7, 2020
We study the dependence structure of market states by calculating empirical pairwise copulas of daily stock returns. We consider both original returns, which exhibit time-varying trends and volatilities, as well as locally normalized returns, where the nonstationarity has been removed. The empirical pairwise copula for each state is compared with a bivariate K-copula. This copula arises from a recently introduced random matrix model, in which nonstationary correlations between returns are modeled by an ensemble of random matrices. The comparison reveals overall good agreement between empirical and analytical copulas, especially for locally normalized returns. Still, there are some deviations in the tails. Furthermore, we find an asymmetry in the dependence structure of market states. The empirical pairwise copulas exhibit a stronger lower tail dependence, particularly in times of crisis.
Keywords: Copulas, Market states, Nonstationarity, Asymmetry, Multivariate mixture, K-copula
JEL Classification: C13, C46, C55, G12, G10
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