How are Africa's emerging stock markets related to advanced markets? Evidence from copulas

- The dependence structure between African and advanced stock markets is examined.
- We examine whether African stocks react to extreme movement in advanced markets.
- Dependence structure is time-varying and differed across African stock markets.
- The results imply no downside spillover effects from advanced to African stock markets.
- African stocks could offer portfolio diversification gains but within some limits.

The finance literature provides ample evidence that diversification benefits hinges on dependence between assets returns. A notable feature of the recent financial crisis is the extent to which assets that had hitherto moved mostly independently suddenly moved together resulting in joint losses in most advanced markets. This provides grounds to uncover the relative potential of African markets to provide diversification benefits by means of their correlation with advanced markets. Therefore, we examine the dependence structure between advanced and emerging African stock markets using copulas. Several findings are documented. First, dependence is time-varying and weak for most African markets, except South Africa. Second, we find evidence of asymmetric dependence, suggesting that stock return comovement varies in bearish and bullish markets. Third, extreme downward stock price movements in the advanced markets do not have significant spillover effects on Africa's emerging stock markets. Our results, implying that African markets, with the exception of South Africa, are immune to risk spillover from advanced markets, improves the extant literature and have implications for portfolio diversification and risk management.