The Correlation Structure of Unexpected Returns in U.S. Equities

38 Pages Posted: 12 Jan 2007

See all articles by R. Brian Balyeat

R. Brian Balyeat

Xavier University - Department of Finance

Jayaram Muthuswamy

Kent State University

Multiple version iconThere are 2 versions of this paper

Date Written: January 11, 2007

Abstract

This paper examines the correlations between unexpected market moves and unexpected equity portfolio moves conditional upon market performance. Unexpected returns are derived from a two stage regime switching model. The model allows for time-varying expected returns where the market portfolio alone dictates the regime switching process. Unexpected negative market movements are not accompanied by increasing correlations. Portfolios exhibit a natural hedge where correlations during extreme unexpected market downturns are generally negative. Additionally, during unexpected market upswings, correlations increase. Using the results from unconditional analysis would lead to overhedging during market downturns and underhedging during market upswings.

Keywords: Large returns, conditional correlation, equity portfolios, diversification, portfolio performance, heteroskedasticity

JEL Classification: G11, G12

Suggested Citation

Balyeat, Ralph Brian and Muthuswamy, Jayaram, The Correlation Structure of Unexpected Returns in U.S. Equities (January 11, 2007). Available at SSRN: https://ssrn.com/abstract=956614 or http://dx.doi.org/10.2139/ssrn.956614

Ralph Brian Balyeat (Contact Author)

Xavier University - Department of Finance ( email )

3800 Victory Parkway
Cincinnati, OH 45207
United States
513 745-3013 (Phone)
513 745-4383 (Fax)

Jayaram Muthuswamy

Kent State University ( email )

Kent, OH 44242
United States

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