Evaluating Correlation Breakdowns During Periods of Market Volatility

By M. Loretan, William B. English. 2000

256 citations recorded by the source corpus.

Financial market observers have noted that during periods of high market volatility, correlations between asset prices can differ substantially from those seen in quieter markets. For example, correlations among yield spreads were substantially higher during the fall of 1998 than in earlier or later periods. Such differences in correlations have been attributed either to structural breaks in the underlying distribution of returns or to \\"contagion\\" across markets that occurs only during periods of market turbulence. However, we argue that the differences may reflect nothing more than time-varying sampling volatility. As noted by Boyer, Gibson and Loretan (1999), increases in the volatility of returns are generally accompanied by an increase in sampling correlations even when the true correlations are constant. We show that this result is not just of theoretical interest: When we consider quarterly measures of volatility and correlation for three pairs of asset returns, we find that the theoretical relationship can explain much of the movement in correlations over time. We then examine the implications of this link between measures of volatility and correlation for risk management, bank supervision, and monetary policy making.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/67574b31e747e5e402f2512f4e324abe7f301998

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Citations in the corpus

Increased Correlation in Bear Markets (2002, unknown): “A number of studies have dealt with the estimation of sizedependent correlation—Ramchand and Susmel (1998), Longin and Solnik (2001), Boyer, Gibson, and Loretan (1999), and Loretan and English (2000).”
Measuring financial contagion:a copula approach (2007, background): “3 See also Loretan and English (2000). the continuation in times of increased volatility of the strong dependence among international markets that exists in tranquil times.”
Emerging Markets Finance (2003, background): “When external country-level corporate governance is weak, it is possible that internal governance in the form of concentrated ownership will step in to fill the void (see Himmelberg, Hubbard and Love (2002)).”
Modeling exchange rate dependence dynamics at different time horizons (2010, background): “…dependence is timevarying , a fact that has raised considerable interest in the dynamic behavior of correlation between different risks as a function of time; see for instance Boyer et al. (1999), Engle (2009), Longin and Solnik (2001), Loretan and English (2000) and Loretan and Phillips (1994).”
Contagion as a domino effect in global stock markets (2009, unknown): “1 See King and Wadhwani (1990), Lee and Kim (1993), Loretan and English (2000) and Forbes and Rigobon (2002).”