International Correlation Asymmetries: Frequent-but-Small and Infrequent-but-Large Equity Returns

Bruno Solnik and Thaisiri Watewai

No 31, PIER Discussion Papers from Puey Ungphakorn Institute for Economic Research

Abstract: We propose a novel regime-switching model to study correlation asymmetries in international equity markets. We decompose returns into frequent-but-small diffusion and infrequent-but-large jumps, and derive an estimation method for many countries. We find that correlations due to jumps, not diffusion, increase markedly in bad markets leading to correlation breaks during crises. Our model provides a better description of correlation asymmetries than GARCH, copula and stochastic volatilit ymodels. Good and bad regimes are persistent. Regime changes are detected rapidly and risk diversification allocations are improved. Asset allocation results in and out-of-sample are superior to other models including the $1/N$ strategy.

Keywords: Correlation Breaks; Asset Allocation; International Equity Markets (search for similar items in EconPapers)
JEL-codes: G01 G11 G15 (search for similar items in EconPapers)
Pages: 58 pages
Date: 2016-06
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Citations: View citations in EconPapers (4)

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