Is the potential for inter- and intro- continental diversification disappearing? A vine copula approach

Cathy Ning () and Wanling Huang ()
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Cathy Ning: Department of Economics, Ryerson University, Toronto, Canada
Wanling Huang: Department of Economics and Finance, University of Texas Rio Grande Valley

No 92, Working Papers from Toronto Metropolitan University, Department of Economics

Abstract: Literature has documented asymmetric nonlinear dependence and disappearing diversification benefit in developed stock markets. This leads to a harder time for international diversification. In this paper, we reexamine the co-movements/interdependence of international stock markets from a new perspective. Specifically, we investigate the inter- and intra- continents dependence of developed stock markets in order to identify possibly further diversification potential. To the best of our knowledge, this is the first paper investigating dependence of international stock markets from the perspective of continent level. We use the approach of vine copulas to study the dependence. The advantage of vine copula approach is that it allows for high dimensions and is also flexible in accommodation of different dependence structure in each pairs via a rich variety of bivariate copulas as its building blocks. We use weekly data from countries in North America (US and Canada), Europe (UK, Germany, and France) and East Asia (Japan, Korea, Hong Kong, and Singapore). The vine copula identified overall dependence structure of all pairs considered shows a weaker dependence across di¤er-ent continents than within a continent. We also find that the dependence measured by either the linear correlations or tail dependence is much lower across continents than within the same continent. We further examine the change of dependence before (period 1) and after the 2008 global financial crisis (period 2), though the dependence has generally increased within the same continent in period 2 during and after the cri-sis, the dependence across continents has only slightly increased in the second period, which is specially so across Asia-Europe and across Asia-North America. Thus the diversification potential within a continent is disappearing but there exists significant intra- continents diversification potential especially between Asia and other continents.

Keywords: Vine copulas; Tail dependence; International financial markets; Inter-continent; Intra-continents; Diversification potential (search for similar items in EconPapers)
JEL-codes: C58 G11 G15 G32 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2018-08
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