Volatility Co-Movement in Stock Markets

Abstract

The volatility and log-price collective movements among stocks of a given market are studied in this work using co-movement functions inspired by similar functions in the physics of many-body systems, where the collective motions are a signal of structural rearrangement. This methodology is aimed to identify the cause of coherent changes in volatility or price. The function is calculated using the product of the variations in volatility (or price) of a pair of stocks, averaged over all pair particles. In addition to the global volatility co-movement, its distribution according to the volatility of the stocks is also studied. We find that stocks with similar volatility tend to have a greater co-movement than stocks with dissimilar volatility, with a general decrease in co-movement with increasing volatility. On the other hand, when the average volatility (or log-price) is subtracted from the stock volatility (or log-price), the co-movement decreases notably and becomes almost zero. This result, interpreted within the background of many body physics, allows us to identify the index motion as the main source for the co-movement. Finally, we confirm that during crisis periods, the volatility and log-price co-movement are much higher than in calmer periods.

Keywords

• co-movement
• volatility
• econophysics
• stock market