Comparison between response dynamics in transition economies and developed economies

Forecasting Volatility: Evidence from the Saudi Stock Market

The purpose of this paper is to evaluate the forecasting performance of linear and non-linear generalized autoregressive conditional heteroskedasticity (GARCH)–class models in terms of their in-sample and out-of-sample forecasting accuracy for the Tadawul All Share Index (TASI) and the Tadawul Industrial Petrochemical Industries Share Index (TIPISI) for petrochemical industries. We use the daily price data of the TASI and the TIPISI for the period of 10 September 2007 to 26 February 2015. The results suggest that the Asymmetric Power of ARCH (APARCH) model is the most accurate model in the GARCH class for forecasting the volatility of both the TASI and the TIPISI in the context of petrochemical industries, as this model outperforms the other models in model estimation and daily out-of-sample volatility forecasting of the two indices. This study is useful for the dataset examined, because the results provide a basis for traders, policy-makers, and international investors to make decisions using this model to forecast the risks associated with investing in the Saudi stock market, within certain limitations.

Agent-based model with multi-level herding for complex financial systems

In complex financial systems, the sector structure and volatility clustering are respectively important features of the spatial and temporal correlations. However, the microscopic generation mechanism of the sector structure is not yet understood. Especially, how to produce these two features in one model remains challenging. We introduce a novel interaction mechanism, i.e., the multi-level herding, in constructing an agent-based model to investigate the sector structure combined with volatility clustering. According to the previous market performance, agents trade in groups, and their herding behavior comprises the herding at stock, sector and market levels. Further, we propose methods to determine the key model parameters from historical market data, rather than from statistical fitting of the results. From the simulation, we obtain the sector structure and volatility clustering, as well as the eigenvalue distribution of the cross-correlation matrix, for the New York and Hong Kong stock exchanges. These properties are in agreement with the empirical ones. Our results quantitatively reveal that the multi-level herding is the microscopic generation mechanism of the sector structure, and provide new insight into the spatio-temporal interactions in financial systems at the microscopic level.

Correlation and network analysis of global financial indices

Random matrix theory (RMT) and network methods are applied to investigate the correlation and network properties of 20 financial indices. The results are compared before and during the financial crisis of 2008. In the RMT method, the components of eigenvectors corresponding to the second largest eigenvalue form two clusters of indices in the positive and negative directions. The components of these two clusters switch in opposite directions during the crisis. The network analysis uses the Fruchterman-Reingold layout to find clusters in the network of indices at different thresholds. At a threshold of 0.6, before the crisis, financial indices corresponding to the Americas, Europe, and Asia-Pacific form separate clusters. On the other hand, during the crisis at the same threshold, the American and European indices combine together to form a strongly linked cluster while the Asia-Pacific indices form a separate weakly linked cluster. If the value of the threshold is further increased to 0.9 then the European indices (France, Germany, and the United Kingdom) are found to be the most tightly linked indices. The structure of the minimum spanning tree of financial indices is more starlike before the crisis and it changes to become more chainlike during the crisis. The average linkage hierarchical clustering algorithm is used to find a clearer cluster structure in the network of financial indices. The cophenetic correlation coefficients are calculated and found to increase significantly, which indicates that the hierarchy increases during the financial crisis. These results show that there is substantial change in the structure of the organization of financial indices during a financial crisis.

Quantifying and modeling long-range cross correlations in multiple time series with applications to world stock indices

We propose a modified time lag random matrix theory in order to study time-lag cross correlations in multiple time series. We apply the method to 48 world indices, one for each of 48 different countries. We find long-range power-law cross correlations in the absolute values of returns that quantify risk, and find that they decay much more slowly than cross correlations between the returns. The magnitude of the cross correlations constitutes "bad news" for international investment managers who may believe that risk is reduced by diversifying across countries. We find that when a market shock is transmitted around the world, the risk decays very slowly. We explain these time-lag cross correlations by introducing a global factor model (GFM) in which all index returns fluctuate in response to a single global factor. For each pair of individual time series of returns, the cross correlations between returns (or magnitudes) can be modeled with the autocorrelations of the global factor returns (or magnitudes). We estimate the global factor using principal component analysis, which minimizes the variance of the residuals after removing the global trend. Using random matrix theory, a significant fraction of the world index cross correlations can be explained by the global factor, which supports the utility of the GFM. We demonstrate applications of the GFM in forecasting risks at the world level, and in finding uncorrelated individual indices. We find ten indices that are practically uncorrelated with the global factor and with the remainder of the world indices, which is relevant information for world managers in reducing their portfolio risk. Finally, we argue that this general method can be applied to a wide range of phenomena in which time series are measured, ranging from seismology and physiology to atmospheric geophysics.