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Increased Correlation in Bear Markets

Rachel Campbell, Kees Koedijk and Paul Kofman
Financial Analysts Journal
Vol. 58, No. 1 (Jan. - Feb., 2002), pp. 87-94
Published by: CFA Institute
Stable URL: http://www.jstor.org/stable/4480371
Page Count: 8
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Since scans are not currently available to screen readers, please contact JSTOR User Support for access. We'll provide a PDF copy for your screen reader.
Increased Correlation in Bear Markets
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Abstract

A number of studies have provided evidence of increased correlations in global financial market returns during bear markets. Other studies, however, have shown that some of this evidence may be biased. We derive an alternative to previous estimators for implied correlation that is based on measures of portfolio downside risk and that does not suffer from bias. The unbiased quantile correlation estimates are directly applicable to portfolio optimization and to risk management techniques in general. This simple and practical method 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 found evidence of significant increased correlation in international equity returns in bear markets. This finding proves the importance of providing a tail-adjusted mean-variance covariance matrix.

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