Analysis of returns, correlation and volatilities of equity markets: New evidence from 6 OECD countries during the US financial crisis

Abstract

We extend previous researches on ‘correlations and volatilities in stock markets’ by incorporating ‘excess returns’ in the model and utilize SUR estimations. We also consider the role of US excess returns and US stock market volatilities (VIX) in the analysis. Finally, we investigate the role of TED spread, CDS spread and foreign exchange market volatilities (FXV) in the dynamics of excess returns, correlations and volatilities. First, when excess returns are included in the model, we show that one period ahead excess returns can explain both the correlations and volatilities and one-period ahead volatilities can explain both the excess returns and volatilities while one period ahead correlations cannot explain excess returns or volatilities. Second, we demonstrate that US excess returns increase all 6 countries’ excess returns and US stock market volatilities increase all 6 countries’ stock market volatiles. Finally, we report that lead-lag relationships among those three variables are reinforced by US TED spread, i.e., high TED spread reduce excess returns but it is shown that CDS spread is insignificant. Our findings shed some important implications on international risk diversification, since deteriorated financial market situations which are measured by TED spread and FXV accelerate the link between the correlations, market returns and volatilities.