Correlation Dynamics and International Diversification Benefits

Peter F. Christoffersen; Vihang Errunza; Kris Jacobs; Xisong Jin

doi:10.1016/j.ijforecast.2014.01.001

Correlation Dynamics and International Diversification Benefits

Peter F. Christoffersen, Vihang Errunza, Kris Jacobs, Xisong Jin

Department of Finance

Research output: Contribution to journal › Journal article › Research › peer-review

Abstract

Forecasting the evolution of security co-movements is critical for asset pricing and portfolio allocation. Hence, we investigate patterns and trends in correlations over time using weekly returns for developed markets (DMs) and emerging markets (EMs) over the period 1973–2012. We show that it is possible to model co-movements for many countries simultaneously using BEKK, DCC, and DECO models. Empirically, we find that correlations have trended upward significantly for both DMs and EMs. Based on a time-varying measure of diversification benefits, we find that it is not possible to circumvent the increasing correlations in a long-only portfolio by adjusting the portfolio weights over time. However, we do find some evidence that adding EMs to a DM-only portfolio increases diversification benefits.

Original language	English
Journal	International Journal of Forecasting
Volume	30
Issue number	3
Pages (from-to)	807-824
ISSN	0169-2070
DOIs	https://doi.org/10.1016/j.ijforecast.2014.01.001
Publication status	Published - 2014

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Cite this

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title = "Correlation Dynamics and International Diversification Benefits",

abstract = "Forecasting the evolution of security co-movements is critical for asset pricing and portfolio allocation. Hence, we investigate patterns and trends in correlations over time using weekly returns for developed markets (DMs) and emerging markets (EMs) over the period 1973–2012. We show that it is possible to model co-movements for many countries simultaneously using BEKK, DCC, and DECO models. Empirically, we find that correlations have trended upward significantly for both DMs and EMs. Based on a time-varying measure of diversification benefits, we find that it is not possible to circumvent the increasing correlations in a long-only portfolio by adjusting the portfolio weights over time. However, we do find some evidence that adding EMs to a DM-only portfolio increases diversification benefits.",

keywords = "Asset pricing, Asset allocation, Dynamic conditional correlation (DCC), Dynamic equicorrelation (DECO)",

author = "Christoffersen, {Peter F.} and Vihang Errunza and Kris Jacobs and Xisong Jin",

year = "2014",

doi = "10.1016/j.ijforecast.2014.01.001",

language = "English",

volume = "30",

pages = "807--824",

journal = "International Journal of Forecasting",

issn = "0169-2070",

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TY - JOUR

T1 - Correlation Dynamics and International Diversification Benefits

AU - Christoffersen, Peter F.

AU - Errunza, Vihang

AU - Jacobs, Kris

AU - Jin , Xisong

PY - 2014

Y1 - 2014

N2 - Forecasting the evolution of security co-movements is critical for asset pricing and portfolio allocation. Hence, we investigate patterns and trends in correlations over time using weekly returns for developed markets (DMs) and emerging markets (EMs) over the period 1973–2012. We show that it is possible to model co-movements for many countries simultaneously using BEKK, DCC, and DECO models. Empirically, we find that correlations have trended upward significantly for both DMs and EMs. Based on a time-varying measure of diversification benefits, we find that it is not possible to circumvent the increasing correlations in a long-only portfolio by adjusting the portfolio weights over time. However, we do find some evidence that adding EMs to a DM-only portfolio increases diversification benefits.

AB - Forecasting the evolution of security co-movements is critical for asset pricing and portfolio allocation. Hence, we investigate patterns and trends in correlations over time using weekly returns for developed markets (DMs) and emerging markets (EMs) over the period 1973–2012. We show that it is possible to model co-movements for many countries simultaneously using BEKK, DCC, and DECO models. Empirically, we find that correlations have trended upward significantly for both DMs and EMs. Based on a time-varying measure of diversification benefits, we find that it is not possible to circumvent the increasing correlations in a long-only portfolio by adjusting the portfolio weights over time. However, we do find some evidence that adding EMs to a DM-only portfolio increases diversification benefits.

KW - Asset pricing

KW - Asset allocation

KW - Dynamic conditional correlation (DCC)

KW - Dynamic equicorrelation (DECO)

U2 - 10.1016/j.ijforecast.2014.01.001

DO - 10.1016/j.ijforecast.2014.01.001

M3 - Journal article

VL - 30

SP - 807

EP - 824

JO - International Journal of Forecasting

JF - International Journal of Forecasting

SN - 0169-2070

IS - 3

ER -