Increased Correlation in Bear Markets: A Downside Risk Perspective

26 Pages Posted: 14 Feb 2002

See all articles by Rachel A.J. Pownall

Rachel A.J. Pownall

Tilburg University - Department of Finance; Maastricht University - Department of Finance

Kees C. G. Koedijk

Tilburg University - Department of Finance

Paul Kofman

The University of Melbourne

Date Written: January 2002

Abstract

A number of studies have provided evidence of increased correlation in global financial market returns during bear markets. Others, however, have shown that some of this evidence may have been biased. We derive an alternative estimator for implied correlation based on portfolio downside risk measures that does not suffer from this bias. These unbiased quantile correlation estimates are directly applicable to portfolio optimization and to risk management techniques in general. This simple and practical approach captures the increasing correlation in extreme market conditions while providing a pragmatic approach to understanding correlation structure in multivariate return distributions. Based on data for international equity markets we find evidence of significant increased correlation in extreme returns in international equity markets. This proves the importance of providing a tail adjusted mean-variance covariance matrix.

Keywords: International equity markets, correlation, extreme returns, downside risk

JEL Classification: G11, G15

Suggested Citation

Pownall, Rachel Ann Jane and Koedijk, Kees G. and Kofman, Paul, Increased Correlation in Bear Markets: A Downside Risk Perspective (January 2002). CEPR Discussion Paper No. 3172. Available at SSRN: https://ssrn.com/abstract=300724

Rachel Ann Jane Pownall (Contact Author)

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Maastricht University - Department of Finance ( email )

Maastricht, 6200 MD
Netherlands

Kees G. Koedijk

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 4663048 (Phone)
+31 13 4662052 (Fax)

Paul Kofman

The University of Melbourne ( email )

Faculty of Economics and Commerce
Department of Finance
Parkville, Victoria 3010
Australia
61 3 8344 3794 (Phone)

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