Are Correlations Constant? Empirical and Theoretical Results on Popular Correlation Models in Finance

Item Type Journal paper
Abstract

Multivariate GARCH models have been designed as an extension of their univariate counterparts. Such a view is appealing from a modeling perspective but imposes correlation dynamics that are similar to time-varying volatility. In this paper, we argue that correlations are quite different in nature. We demonstrate that the highly unstable and erratic behavior that is typically observed for the correlation among financial assets is to a large extent a statistical artefact. We provide evidence that spurious correlation dynamics occur in response to financial events that are sufficiently large to cause a structural break in the time-series of correlations. A measure for the autocovariance structure of conditional correlations allows us to formally demonstrate that the volatility and the persistence of daily correlations are not primarily driven by financial news but by the level of the underlying true correlation. Our results indicate that a rolling-window sample correlation is often a better choice for empirical applications in finance.

Authors Adams, Zeno; Füss, Roland & Glück, Thorsten
Journal or Publication Title Journal of banking and finance
Language English
Keywords Change-point tests; Correlation breaks; Dynamic conditional correlation (DCC); Multivariate GARCH models; Spurious conditional correlation
Subjects business studies
economics
finance
HSG Classification contribution to scientific community
HSG Profile Area None
Refereed Yes
Date November 2017
Publisher Elsevier North-Holland
Place of Publication Amsterdam
Volume 84
Page Range 9-24
Number of Pages 23
ISSN 0378-4266
ISSN-Digital 1872-6372
Publisher DOI 10.1016/j.jbankfin.2017.07.003
Official URL http://www.sciencedirect.com/science/article/pii/S...
Contact Email Address roland.fuess@unisg.ch
Depositing User Geraldine Frei-Böbel
Date Deposited 27 Jun 2016 14:42
Last Modified 06 Jul 2018 10:05
URI: https://www.alexandria.unisg.ch/publications/248601

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Citation

Adams, Zeno; Füss, Roland & Glück, Thorsten (2017) Are Correlations Constant? Empirical and Theoretical Results on Popular Correlation Models in Finance. Journal of banking and finance, 84 9-24. ISSN 0378-4266

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https://www.alexandria.unisg.ch/id/eprint/248601
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