International Correlation Asymmetries: Frequent-But-Small and Infrequent-But-Large Equity Returns

Review of Asset Pricing Studies, December 2016

64 Pages Posted: 23 Nov 2014 Last revised: 10 Mar 2017

See all articles by Bruno Solnik

Bruno Solnik

Hong Kong University of Science & Technology (HKUST) - Department of Finance ; HEC Paris - Departement Finance et Economie

Thaisiri Watewai

Chulalongkorn University - Department of Banking & Finance

Date Written: May 28, 2016

Abstract

We propose a novel regime-switching model to study correlation asymmetries in international equity markets. We decompose returns into frequent-but-small diffusion and infrequent-but-large jumps, and derive an estimation method for many countries. We find that correlations due to jumps, not diffusion, increase markedly in bad markets leading to correlation breaks during crises. Our model provides a better description of correlation asymmetries than GARCH, copula and stochastic volatility models. Good and bad regimes are persistent. Regime changes are detected rapidly and risk diversifi cation allocations are improved. Asset allocation results in and out-of-sample are superior to other models including the 1/N strategy.

Keywords: Regime switching, systemic risk, correlation breakdown, exceedance correlation, asset allocation, international equity markets

JEL Classification: F30, G11

Suggested Citation

Solnik, Bruno and Watewai, Thaisiri, International Correlation Asymmetries: Frequent-But-Small and Infrequent-But-Large Equity Returns (May 28, 2016). Review of Asset Pricing Studies, December 2016, Available at SSRN: https://ssrn.com/abstract=2529613 or http://dx.doi.org/10.2139/ssrn.2529613

Bruno Solnik (Contact Author)

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong

HEC Paris - Departement Finance et Economie ( email )

1, rue de la Liberation
Jouy-en-Josas Cedex, 78351
France
+33 1 39 67 72 84 (Phone)
+33 1 39 67 70 85 (Fax)

Thaisiri Watewai

Chulalongkorn University - Department of Banking & Finance ( email )

Thailand

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