The Impact of Large Changes in Asset Prices on Intra-Market Correlations in the Domestic and International Markets
Posted: 18 May 2009
Date Written: May 12, 2009
We consider the impact of "large" changes in asset prices on intra-market correlations in domestic and international markets. Assuming normally distributed asset returns, we show that the absolute magnitude of the correlation, conditional on a change greater than or equal to a given absolute size of one of the variables, is monotonically increasing in the magnitude of that absolute change. Empirical tests using domestic and international-market data support this theoretical result. These results have significant implications for portfolio management, hedging interest rate risk, tests of asset pricing models, Roll’s concern with asset pricing models’ explanatory power, and implementation of Value-at-Risk.
Keywords: Conditional correlation, Roll's R2, Value-at-Risk
JEL Classification: C10, G12
Suggested Citation: Suggested Citation