Behavior of Extreme Dependence between Stock Markets when the Regime Shifts

We propose a methodology based on multivariate extreme value theory, to analyze the dependence between markets during the financial crisis. We argue that extreme dependence based on block maximum is a more appropriate measure to study dependence between stock markets, when a regime shifts, than other alternatives. With this methodology, we are able to detect the increase in the extreme dependences between US and other markets during the 2008 financial crisis where traditional approaches fail to do so. In addition, the estimated dependent function allows one to quantify maximum impact of the crisis on each individual market. We then propose the use of a conditional loss distribution as a constructive tool for a stress test analysis in risk management study. Stress test levels with respect to 2008 financial data calculated from the conditional loss distribution are given.