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Correlation dynamics and international diversification benefits

Author

Listed:
  • Christoffersen, Peter
  • Errunza, Vihang
  • Jacobs, Kris
  • Jin, Xisong

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.

Suggested Citation

  • Christoffersen, Peter & Errunza, Vihang & Jacobs, Kris & Jin, Xisong, 2014. "Correlation dynamics and international diversification benefits," International Journal of Forecasting, Elsevier, vol. 30(3), pages 807-824.
    • Handle: RePEc:eee:intfor:v:30:y:2014:i:3:p:807-824
    DOI: 10.1016/j.ijforecast.2014.01.001
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    More about this item

    Keywords

    Asset pricing; Asset allocation; Dynamic conditional correlation (DCC); Dynamic equicorrelation (DECO);
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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