DP2538 Extreme Correlation of International Equity Markets

Author(s): Fran├žois Longin, Bruno H Solnik
Publication Date: August 2000
Keyword(s): Correlation, Extreme Value Theory, International Equity Markets, Volatility
JEL(s): F30, G15
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2538

Testing the hypothesis that international equity market correlation increases in volatile times is a difficult exercise and misleading results have often been reported in the past because of a spurious relationship between correlation and volatility. This paper focuses on extreme correlation, that is to say the correlation between returns in either the negative or positive tail of the multivariate distribution. Using ?extreme value theory? to model the multivariate distribution tails, we derive the distribution of extreme correlation for a wide class of return distributions. Using monthly data on the five largest stock markets from 1958 to 1996, we reject the null hypothesis of multivariate normality for the negative tail, but not for the positive tail. We also find that correlation is not related to market volatility per se but to the market trend. Correlation increases in bear markets, but not in bull markets.