Temporal Evolution of Financial Market Correlations

Daniel J. Fenn, Mason A. Porter, Stacy Williams, Mark McDonald, Neil F. Johnson and Nick S. Jones

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Abstract: We investigate financial market correlations using random matrix theory and principal component analysis. We use random matrix theory to demonstrate that correlation matrices of asset price changes contain structure that is incompatible with uncorrelated random price changes. We then identify the principal components of these correlation matrices and demonstrate that a small number of components accounts for a large proportion of the variability of the markets that we consider. We then characterize the time-evolving relationships between the different assets by investigating the correlations between the asset price time series and principal components. Using this approach, we uncover notable changes that occurred in financial markets and identify the assets that were significantly affected by these changes. We show in particular that there was an increase in the strength of the relationships between several different markets following the 2007--2008 credit and liquidity crisis.

Date: 2010-11, Revised 2011-05
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Published in Physical Review E, Vol. 84, No. 2: 026109 (2011)

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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1011.3225

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