The dynamics of volatility and correlation during periods of crisis: Implications for active asset management

Marcello Esposito ()
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Marcello Esposito: Marcello Esposito, Università ‘C. Cattaneo’, Scuola di Economia e Management

Journal of Asset Management, 2016, vol. 17, issue 3, No 1, 135-140

Abstract: Abstract The 2007–2008 financial crisis will be remembered for many exceptional facts. Among them, the spectacular increase in stock market’s volatility and correlation. This has been interpreted as a sort of structural break in stock market’s dynamics and a proof of the fallacy of one of the central tenets of financial advisory services: the importance of portfolio diversification. I will show, on the contrary, that this phenomenon is not at all surprising, given the increase in market volatility, and it derives from a very simple dynamic CAPM model. I calibrate the model over the last 20 years and show that it fits very well the observed dynamic of stock markets’ volatility and correlation. Finally, I use the model to investigate if the 2007–2008 environment should have been detrimental to bottom-up managers and favorable for top-down managers, as far as ‘alpha’ creation is concerned.

Keywords: financial crisis; volatility; diversification; correlation; active asset management; alpha generation (search for similar items in EconPapers)
Date: 2016
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DOI: 10.1057/jam.2016.5

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