Systematic extreme correlation of Chinese stock market

Abstract

ABSTRACT This article investigates the impact of systematic extreme correlations on the cross-section returns in the Chinese stock market. First, it extends the proposed extreme downside correlation (EDC) to the extreme upside correlation (EUC), and employs them to measure systematic tail risk. We find the asymmetry of systematic extreme correlations that EDC is always greater than EUC in the Chinese stock market. Then, we calculate the average returns of portfolios sorted by extreme measures and find that systematic extreme measures have a negative relationship with the Chinese stock returns. After controlling other potential variables such as size, lagged return, higher moments and higher co-moments, these two extreme correlation measures still have significantly negative relationship with stock returns. The results suggest that EDC and EUC help explain the cross-section returns of the Chinese stocks and manage tail risk for investors.