Tail Dependence between Stock Index Returns and Foreign Exchange Rate Returns − A Copula Approach

25 Pages Posted: 22 Sep 2011

See all articles by Fangxia Lin

Fangxia Lin

City University of New York (CUNY) - New York City College of Technology

Date Written: July 1, 2011

Abstract

The aim of this paper is to estimate the tail dependence between stock index returns and foreign exchange rate returns for five selected East Asian economies (Hong Kong, Indonesia, South Korea, Singapore, and Taiwan). We apply the concept of copula to model the dependence structure, especially in the tail area, between the two returns series for each country under examination. We first filter the raw returns using AR(k)-GARCH (p,q)-type models to make sure the probability integral transforms are i.i.d. Uniform(0.1), and then we fit the resulting series to the copula models. Our major findings are, for the two developed economies (Hong Kong and Singapore), there exists neither lower nor upper tail dependence between stock index returns and exchange rate returns for the period under examination. For the three emerging markets, Indonesia and South Korea have much stronger lower tail dependency than right tail, indicating that the higher probability of double loss than a double gain. Taiwan has symmetric tail dependence with similar upper and lower tail coefficients. Our findings have important implications for international diversification and market risk management.

Keywords: Tail dependence, Asymmetric dependence, GARCH Model, Empirical Copula, SJC copula, Time-varying SJC copula, Maximum likelihood Method

JEL Classification: G15

Suggested Citation

Lin, Fangxia, Tail Dependence between Stock Index Returns and Foreign Exchange Rate Returns − A Copula Approach (July 1, 2011). Available at SSRN: https://ssrn.com/abstract=1931726 or http://dx.doi.org/10.2139/ssrn.1931726

Fangxia Lin (Contact Author)

City University of New York (CUNY) - New York City College of Technology ( email )

300 Jay St
Brooklyn, NY 11201
United States

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