A new view of risk contagion by decomposition of dependence structure: Empirical analysis of Sino-US stock markets

Abstract

With the fragile recovery of world economy and increasing financial uncertainty, global capital allocations and risk management become more sensitive to the risk spillover and contagion among financial markets, especially in extreme conditions. We propose a new view to detect risk contagion by the local comonotonicity and counter-monotonicity decomposed from dependence structure. It allows us to distinguish risk spillover, portfolio diversification risk, mild, moderate and severe contagions in the uniform framework. We apply it to analyze the identifications and degrees of risk contagion between Sino-US stock markets, and then find that they experience higher frequencies of portfolio diversification risk and moderate contagions while fewer proportions of mild and severe contagions. Impact factors from United States play the main role in increasing the odd ratio of risk spillover and moderate contagion between Sino-US stock markets. Our results can help global investors to develop sophisticated risk strategies by revealing structure information of dependence.