The Variance Implied Conditional Correlation

The European Journal of Finance, forthcoming, 2019

30 Pages Posted: 27 Feb 2018 Last revised: 20 May 2019

See all articles by Andres Algaba

Andres Algaba

Vrije Universiteit Brussel (VUB)

Kris Boudt

Ghent University; Vrije Universiteit Brussel; Vrije Universiteit Amsterdam

Steven Vanduffel

Vrije Universiteit Brussel (VUB)

Date Written: August 2, 2018

Abstract

We apply univariate GARCH models to construct a computationally simple filter for estimating the conditional correlation matrix of asset returns. The proposed Variance Implied Conditional Correlation (VICC) exploits the polarization result that links the correlation between two standardized variables with the variances of linear combinations thereof. In a Monte Carlo study, we show that the VICC yields accurate correlation estimates for common choices of the correlation dynamics. We also provide an empirical application to cross hedging that confirms the effectiveness of the VICC.

Keywords: conditional correlation, cross hedging, Dynamic Conditional Correlation (DCC), GARCH, hedge ratio, regularization

JEL Classification: C10, G11

Suggested Citation

Algaba, Andres and Boudt, Kris and Vanduffel, Steven, The Variance Implied Conditional Correlation (August 2, 2018). The European Journal of Finance, forthcoming, 2019. Available at SSRN: https://ssrn.com/abstract=3125020 or http://dx.doi.org/10.2139/ssrn.3125020

Andres Algaba (Contact Author)

Vrije Universiteit Brussel (VUB) ( email )

Pleinlaan 2
http://www.vub.be
Brussels, 1050
Belgium

Kris Boudt

Ghent University ( email )

Sint-Pietersplein 5
Gent, 9000
Belgium

Vrije Universiteit Brussel ( email )

Pleinlaan 2
http://www.vub.ac.be/
Brussels, 1050
Belgium

Vrije Universiteit Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

Steven Vanduffel

Vrije Universiteit Brussel (VUB) ( email )

Pleinlaan 2
Brussels, Brabant 1050
Belgium

HOME PAGE: http://www.stevenvanduffel.com

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