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The correlation puzzle: The interaction of bond and risk correlation

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  • Bethke, Sebastian
  • Kempf, Alexander
  • Trapp, Monika
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    Abstract

    Diversification benefits depend on the correlation between assets. Unfortunately, asset correlation increases when it is most needed. We examine bond correlation using a broad sample of US corporate bonds. We find bond correlation to be higher during the financial crisis in 2008. Increased bond correlation results from higher correlation between corporate bond risk factors. Risk factor correlation increases when investor sentiment worsens. This suggests that corporate bond investors change their perception of risk factors, which results in higher risk factor correlation and finally higher bond correlation. --

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    Bibliographic Info

    Paper provided by University of Cologne, Centre for Financial Research (CFR) in its series CFR Working Papers with number 13-06.

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    Date of creation: 2013
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    Handle: RePEc:zbw:cfrwps:1306

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    Keywords: bond correlation; credit risk; liquidity; risk factor correlation; investor sentiment;

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