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Dependence structure of market states

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  • Desislava Chetalova
  • Marcel Wollschlager
  • Rudi Schafer

Abstract

We study the dependence structure of market states by estimating empirical pairwise copulas of daily stock returns. We consider both original returns, which exhibit time-varying trends and volatilities, as well as locally normalized ones, where the non-stationarity 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 non-stationary 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.

Suggested Citation

  • Desislava Chetalova & Marcel Wollschlager & Rudi Schafer, 2015. "Dependence structure of market states," Papers 1503.09004, arXiv.org, revised Jul 2015.
    • Handle: RePEc:arx:papers:1503.09004
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    Cited by:

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    2. Heckens, Anton J. & Guhr, Thomas, 2022. "New collectivity measures for financial covariances and correlations," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 604(C).

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