The Non-Misleading Value of Inferred Correlation: An Introduction to the Cointelation Model
Wilmott, Volume 2013, Issue 67, pages 50-61, September 2013
11 Pages Posted: 26 Apr 2014 Last revised: 21 May 2014
Date Written: 2013
This paper comes together with growing evidence for power law-type scaling of correlation with time, a concept rooted in the original study by Benoit Mandelbrot on concentration of risk. We complete the cointelation model recently introduced via a statistical test, which uses measured correlation in different time gaps. We also provide an approximation of the expectation in the change in measured correlation via these various time steps and use our findings in order to introduce the concept of inferred correlation and the term structure of correlation. We finally illustrate our findings through the example of the relation between oil and BP, and present a few potential applications in the financial industry.
Keywords: cointelation; inferred correlation; measured correlation; cointegration; correlation term structure
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