Modeling Return Rate Correlation between Shanghai and Shenzhen Stock Markets Using Copula Function

This paper explores to model return rate correlation between Shanghai and Shenzhen stock markets, especially to discover tail dependence between them, in order to find simultaneous rise or fall of the two markets. Copula function that is good for modeling tail dependence is applied in this paper. We collect four-year Shanghai and Shenzhen composite index series from 2008 to 2011, and estimate their empirical distributions. Gaussian copula function and t-copula function are used for modeling the two markets' return rate correlation respectively. By comparing them with empirical copula, it is believed that t-copula model is better at modeling return rate correlation of the two stock markets.