Study of the Tail Dependence Structure in Global Financial Markets Using Extreme Value Theory

The presence of tail dependencies invalidates the multivariate normality assumptions in portfolio risk management. The identification of tail (in)dependencies has drawn major attention in empirical financial studies. Yet it is still a challenging issue both theoretically and practically. Previous studies based on either a restrictive model or the null hypothesis of tail (perfect) dependence does not well describe or interpret extreme co-movements in financial markets. This paper examines tail dependence structures underlying a broad range of financial asset classes employing the newly developed tail quotient correlation coefficients. In theory, the original tail quotient correlation coefficient proposed in (Zhang 2008) is adapted to incorporate cases with varying data driven random thresholds. Our empirical results demonstrate different tail dependence structures underlying various global financial markets. Either omission or unanimous treatment of the tail dependence structures for different financial markets will lead to erroneous conclusions or suboptimal investment choices. The multivariate extreme value theory framework in this study has the potential to serve as an useful tool in exploiting arbitrage opportunities, optimizing asset allocations, and building robust risk management strategies