Dependence Structure of Korean Financial Markets Using Copula-GARCH Model

This paper investigates the dependence structure of Korean financial markets (stock, foreign exchange (FX) rates and bond) using copula-GARCH and dynamic conditional correlation (DCC) models. We examine GJR-GARCH with skewed elliptical distributions and four copulas (Gaussian, Student's t, Clayton and Gumbel) to model dependence among returns, and then employ DCC model to describe system-wide correlation dynamics. We analyze the daily returns of KOSPI, FX (WON/USD) and KRX bond index (Gross Price Index) from 2nd May 2006 to 30th June 2014 with 2,063 observations. Empirical result shows that there is significant asymmetry and fat-tail of individual return, and strong tail-dependence among returns, especially between KOSPI and FX returns, during the 2008 Global Financial Crisis period. Focused only on recent 30 months, we find that the correlation between stock and bond markets shows dramatic increase, and system-wide correlation wanders around zero, which possibly indicates market tranquility from a systemic perspective.