Increasing correlations or just fat tails?
Rachel A.J. Campbell,
Kees G. Koedijk and
Authors registered in the RePEc Author Service: Rachel A J Pownall (Campbell) ()
Journal of Empirical Finance, 2008, vol. 15, issue 2, 287-309
Increasing correlation during turbulent market conditions implies a reduction in portfolio diversification benefits. We investigate the robustness of recent empirical results that indicate a breakdown in the correlation structure by deriving theoretical truncated and exceedance correlations using alternative distributional assumptions. Analytical results show that the increase in conditional correlation could be a result of assuming conditional normality for the return distribution. When assuming a popular alternative distribution - the bivariate Student-tr - we find significantly less support for an increase in conditional correlation and conclude that this is due to the presence of fat tails when assuming normality in the return distribution.
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:15:y:2008:i:2:p:287-309
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