Correlation Breakdown and the Influence of Correlations on VaR

23 Pages Posted: 17 Apr 2014

See all articles by Andreas Nawroth

Andreas Nawroth

Credit Suisse AG

Fabrizio Anfuso

PRA, Bank Of England

Fredrik Akesson

Credit Suisse AG

Date Written: April 16, 2014

Abstract

The correlations among assets returns is one of the key components in the construction of a diversified portfolio. It has been observed though that in time of great distress, when a drop in financial markets occurs, correlations tend to increase. As a consequence, the diversification effect is diminished when it is most needed for protecting investors from large losses. In the present work, we provide a method to characterise and measure the breakdown of correlations. We show to which extent the diversification benefit is expected to be reduced and how worst case correlations can augment standard VaR calculations. Finally, we provide a pragmatic way to identify and correct high impact model misspecifications in existing VaR models.

Keywords: Financial crisis, VaR, Correlation breakdown, Stock return asymmetries, Portfolio diversification, Financial markets

JEL Classification: C02, C46, C52, C58

Suggested Citation

Nawroth, Andreas and Anfuso, Fabrizio and Akesson, Fredrik, Correlation Breakdown and the Influence of Correlations on VaR (April 16, 2014). Available at SSRN: https://ssrn.com/abstract=2425515 or http://dx.doi.org/10.2139/ssrn.2425515

Andreas Nawroth (Contact Author)

Credit Suisse AG ( email )

Giesshübelstrasse 40
Zurich, 8002
Switzerland

Fabrizio Anfuso

PRA, Bank Of England ( email )

20 Moorgate
London, EC2R 6DA
United Kingdom

Fredrik Akesson

Credit Suisse AG ( email )

Giesshübelstrasse 40
Zurich, 8002
Switzerland

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