Modeling the Dynamics of Correlations Between International Equity Volatility Indices

Abstract

I show that volatility indices are more volatile than equity indices, and correlation is higher during periods of high market uncertainty. In this thesis, I consider correlation between volatility markets around the world. This thesis introduces a one-factor model to examine the correlations between volatility markets. I show that for markets where there is a higher level of stock market integration, there is a correspondingly higher degree of volatility market integration. My findings suggest that investors’ expectations about future uncertainty are highly integrated. Applying the dynamic conditional correlation model developed by Engle (2002) to 10 volatility indices across different countries, I show that there is a positive and time-varying correlation between all volatility indices and that the correlation with the underlying equity market index is one factor associated with volatility market integration. I document some evidence of regional integration in volatility markets which suggests that macroeconomic factors should be examined further in future research