Modeling the Time Varying Comovement of Asset Returns

Posted: 25 Apr 1998

See all articles by Kenneth F. Kroner

Kenneth F. Kroner

BlackRock, Inc - San Francisco

Victor K. Ng

International Monetary Fund (IMF) - Research Department; National Bureau of Economic Research (NBER)

Abstract

Existing multivariate models allowing the covariance matrix to be time varying generally impose strong restrictions on how past shocks can affect the covariance matrix. Yet these restrictions are seldom compared and tested. Furthermore, few studies have examined the existence of asymmetric/leverage effects in covariance, even though there are good reasons to believe they exist and have important implications for portfolio management, derivatives pricing and hedging. In this paper, we introduce a set of robust conditional moment tests to detect misspecification in the covariance matrix, and introduce a general model which nests the four most popular multivariate GARCH models and their natural "asymmetric" extensions. The new model is applied to study the dynamic relation between large and small firm returns. Our results suggest that bad news about large firms can cause volatility in both small and large firm returns, while news about small firms, whether good or bad, has minimal effect on the covariance matrix. The conditional covariance between large firm and small firm returns also tends to increase following bad news about large firms but not bad news about small firms.

JEL Classification: G19

Suggested Citation

Kroner, Kenneth F. and Ng, Victor K., Modeling the Time Varying Comovement of Asset Returns. Available at SSRN: https://ssrn.com/abstract=6779

Kenneth F. Kroner (Contact Author)

BlackRock, Inc - San Francisco ( email )

400 Howard Street
San Francisco, CA 94105
United States

Victor K. Ng

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-7671 (Phone)
202-623-6339 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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