Flight to Quality for Large Financial Institutions

Banking and Finance Review, 6.1, 75-90, 2014

Posted: 17 Jan 2016

See all articles by A. Can Inci

A. Can Inci

Bryant University

Hsi-Cheng Li

Bryant University

Joseph McCarthy

Bryant University

Date Written: October 1, 2014

Abstract

Local correlation analysis is used to investigate flight to quality among large financial institutions before, during, and after the financial crisis of 2008-2009. While standard correlation captures general overall linear association, local correlation analysis more accurately captures changes in the associations in response to changing market conditions. Using raw, market-adjusted, and industry-adjusted stock returns of individual banks, we investigate the performance of troubled banks and the change in investing behavior. Investors react to noisy information from the financial difficulties encountered by banking institutions. This reaction results in flight to quality. While the traditional Pearson correlations capture general overall linear association, local correlation analysis captures changes in the association in response to changing market conditions. Thus, local correlation analysis more accurately measures changes in correlation where it matters most: in the loss tail of the distribution of financial returns; leading to more appropriate diversification, portfolio management, and within-industry implications.

Keywords: Flight to quality, Local correlation, Financial Institutions

JEL Classification: G01, G20, G21

Suggested Citation

Inci, Ahmet Can and Li, Hsi-Cheng and McCarthy, Joseph, Flight to Quality for Large Financial Institutions (October 1, 2014). Banking and Finance Review, 6.1, 75-90, 2014. Available at SSRN: https://ssrn.com/abstract=2716328

Ahmet Can Inci (Contact Author)

Bryant University ( email )

1150 Douglas Pike
Smithfield, RI 02917
United States

Hsi-Cheng Li

Bryant University ( email )

1150 Douglas Pike
Smithfield, RI 02917-1284
United States

Joseph McCarthy

Bryant University ( email )

1150 Douglas Pike
Smithfield, RI 02917-1284
United States
401-232-6446 (Phone)

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