Quantitative measurement of the contagion effect between US and Chinese stock market during the financial crisis

Abstract

In this paper, we study the quantitative measurement of contagion effect between US and Chinese stock market during the financial crisis by combining multifractal volatility (MFV) with the copula method. At first, we employ MFV to filter volatility of the two markets due to the existence of heteroskedasticity. Then we use an improved time-varying Clayton copula to estimate the dynamic lower tail dependence (lower Kendall’s τ). After determining crisis and non-crisis periods by Markov regime switching model, we find that the statistical characteristics of lower Kendall’s τ during crisis and non-crisis periods are obviously different. Time-varying lower Kendall’s τ of the crisis period is about 1.87 times that of in non-crisis period on average, indicating that the contagion effect increased about 87% during the crisis period. It is very drastic that the fluctuations of lower tail dependence during crisis period, so the static measurement of contagion effect may not provide effective suggestions for investors. Thus, we propose a dynamic method to measure the strength of contagion effect.