Asymmetries in Financial Returns: A Local Gaussian Correlation Approach

A number of studies have provided evidence that financial returns exhibit asymmetric dependence, such as increased dependence during bear markets. In this paper we introduce the use of a new measure of local dependence (see Hufthammer and Tjøstheim (2008b,a)) to study and quantify this asymmetry. This measure does not suffer from the selection bias of the conditional correlation for Gaussian data, and is able to capture nonlinear dependence. Analysing several financial returns, both monthly and daily data, from the US, UK, German and French market, we confirm results of asymmetry, and are able to quantify the asymmetry. Finally, we discuss possible applications to portfolio selection and the contagion effect, and point out a number of possible extensions.