Returns, correlations, and volatilities in equity markets: Evidence from six OECD countries during the US financial crisis

Abstract

We investigate the dynamic interactions between stock-market excess returns, time-varying correlations and volatilities in six OECD countries and the United States during the US financial crisis and its aftermath. Using the seemingly-unrelated regression (SUR) and panel-regression models with return, correlation, and volatility equations, we show that excess returns can explain both correlations and volatilities and that own volatility can explain both excess returns and correlations. However, we find that correlations can explain neither excess returns nor volatilities. We find new and important evidence that 'excess returns,' US excess returns,' and 'US volatilities' should be included in the analysis of other countries' correlations and volatilities. The US T-bill-LIBOR interest-rate differential (TED spread) and foreign-exchange market volatility (FXV) negatively affect excess returns; however, the credit-default swap spread's effect is insignificant. Our findings are robust with different definitions of the key variables; they also provide important implications for international risk diversification: as financial-market conditions (measured by the TED spread and FXV) deteriotate, the links between stock-market returns,,correlations, and volatilities appear to be strengthened. (C) 2016 Elsevier B.V. All rights reserved.