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Correlation structure of extreme stock returns

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  • P. Cizeau
  • M. Potters
  • J-P. Bouchaud

Abstract

It is commonly believed that the correlations between stock returns increase in high volatility periods. We investigate how much of these correlations can be explained within a simple non-Gaussian one-factor description with time-independent correlations. Using surrogate data with the true market return as the dominant factor, we show that most of these correlations, measured by a variety of different indicators, can be accounted for. In particular, this one-factor model can explain the level and asymmetry of empirical exceedance correlations. However, more subtle effects require an extension of the one-factor model, where the variance and skewness of the residuals also depend on the market return.

Suggested Citation

  • P. Cizeau & M. Potters & J-P. Bouchaud, 2001. "Correlation structure of extreme stock returns," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 217-222.
    • Handle: RePEc:taf:quantf:v:1:y:2001:i:2:p:217-222
    DOI: 10.1080/713665669
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