Critiquing Diversification Benefits through a Simplified Conditional Correlation Estimator

9 Pages Posted: 15 Apr 2024

Date Written: March 28, 2024

Abstract

This paper examines how correlations between asset classes vary across market conditions and introduces a sliding window conditional correlation estimator. Comparing with established methodologies, it assesses correlations between asset classes, focusing on their diversification potential relative to US equities. Results reveal that treasuries generally offer favorable diversification properties, while equities and corporate bonds often fall short. The study also explores how the estimator can be used to measure how correlations vary in response to macroeconomic variables such as interest rates. Overall, findings support existing literature but highlight that extreme tail observations can have a large impact on conclusions when aiming to understanding diversification properties using conditional correlation.

Keywords: correlation, conditional correlation, diversification, portfolio construction, portfolio optimisation

Suggested Citation

Holtes, Grant, Critiquing Diversification Benefits through a Simplified Conditional Correlation Estimator (March 28, 2024). Available at SSRN: https://ssrn.com/abstract=4777167 or http://dx.doi.org/10.2139/ssrn.4777167

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