Analysis of dependence in the G11 countries' financial markets: simulation and empirical evidence

This article investigates the dependence of G10 countries' equity markets on the US market, particularly when the US experiences upturns or downturns in the market. If indeed the dependence is high in the downturn market, then investors will not benefit from international diversification when it is mostly needed. Using daily returns on the stock markets of G11 countries, this study estimates Pearson and rank correlations of G10 markets conditional on the US market falling below and rising above certain levels. The rank correlation is robust to outliers and hence provides stronger evidence than its counterpart. When the US market falls, the dependence between the US market and G10 countries has become notably stronger than that during bull markets, except for Sweden. The observed higher dependence in the bear market is of concern for investors, because it erodes the benefit of international diversification.