How past market movements affect correlation and volatility

Christoph Becker and Wolfgang M. Schmidt

Journal of International Money and Finance, 2015, vol. 50, issue C, 78-107

Abstract: The influence of past stock price movements on correlations and volatilities is essential for understanding diversification and contagion in financial markets. We develop a model that makes the influence of past returns, aggregated into driving factors for correlations and volatilities, explicit. Employing information about recent market movements leads to a more realistic model for the behavior of stock returns in a downturn than conventional models. Our approach offers a fresh perspective on the behavior of stock markets, and provides an alternative to the concept of exceedance correlation. For a US investor we find that international diversification in China or the UK remains beneficial in a crisis.

Keywords: Correlation; Volatility; Financial contagion; Diversification; Exceedance correlation; GARCH models (search for similar items in EconPapers)
JEL-codes: C13 C32 C58 G11 G12 (search for similar items in EconPapers)
Date: 2015
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:50:y:2015:i:c:p:78-107

DOI: 10.1016/j.jimonfin.2014.09.003

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