Tail Dependence Between Chinese And International Stock Markets Under Market Integration

As financial openness increases gradually, China’s stock market is integrating into the global financial market. It is, therefore, necessary for all market participants to examine the trends in dependence, especially tail dependence, between China’s stock market and the international stock market. In this paper, we investigate mainly the trends in tail dependence from2005to2011in China Shanghai A and B shares and H shares respectively with stock markets of the United States, Japan, Hong Kong, Brazil, Russia and India. In particular, the paper discusses several important questions: How to measure the tail dependence? Which model is appropriate? Were there any changes in the dependence trends? If changes existed, when did important changes in the dependence trends occur? How much did the dependence change? Is there any asymmetry in the trends between upper and lower tail dependences? Which tail dependence contributed most to those changes? Whether are the results of trends in dpendence robust?To find answers to these questions, we develop a multiple-regime smooth-transition Copula model. Based on daily total market price index data, we use three Copula-based dependence measures, specifically, upper and lower tail dependences and Pearson’s rho to evaluate dependence from three aspects. The figures of dynamics, degree, and period of structural changes of the three dependence measures are given in this paper. At the same time, asymmetry in upper and lower tail dependences is considered. Then we use weekly data, eliminating the influence of the jet lag, to check robustness.The results indicate a significant change in both upper and lower tail dependences, and provide clear evidence of the asymmetric evolution in upper and lower tail dependences. By comparison, we find that the results in dependence are not robust, which may relate to the imperfection of China’s stock market. What’s more, the tail dependences in A and B shares with the international markets are still low-level and not robust, though they are increasing overall. By comparison, the tail dependences in H shares with the international markets are higher and more robust. With a series of policies, in spite of the increasing openness and promoting dependence, there is still some differences between China’s stock market and the international markets.Based on the results, investors can assess accurately the degree of comovement among stock returns to construct a well diversified portfolio. In addition, to evaluate risk measures, risk managers should take into account interdependence in stock markets. Policy makers also have to pay close attention to the volatility of the international financial markets, and take measures to avoid risk in time.