An Empirical Analysis of the Dependence Structure of International Equity and Bond Markets Using Regime-switching Copula Model

In this paper, we perform an empirical analysis of the dependence structure of international equity and bond markets using the regime-switching copula model. In equity markets, it is observed that negative returns are more strongly dependent than positive returns. This phenomenon is known as asymmetric dependence. The regime-switching copula model, which includes symmetric and asymmetric regimes, is suitable for describing asymmetry. We apply two kinds of flexible multivariate copulas, a skew t copula and a vine copula, to the asymmetric regime to deal with dependencies between two asset classes. In this paper, we analyze three country pairs: the United Kingdom and United States (UK-US), Japan-US, and Italy-US. We find three implications of our empirical analysis. First, highly dependent regimes are different according to the asset pairs. Second, the strength of the asymmetry of each country pair varies, and that of the Japan-US pair is weak. Third, the skew t copula is a better fit to the data, but is not flexible enough to capture extreme dependencies, while the vine copula fits well in spite of having fewer parameters, but cannot express the different extreme dependencies of each asset pair.