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The change of correlation structure across industries:an analysis in the regime-switching framework

  • Masahiko Egami
  • Yuki Shigeta
  • Katsutoshi Wakai

This paper studies changes of correlation structure across industries in the United States equities market in the regime-switching framework. To capture the irreversible structural change and to separate it from the recurring boomingrecession switches, we introduce two Markov chains. We empirically identify the timing of the structural change and confirm that, after the change, the asset return correlations across industries increased. Moreover, the impact of the structural change on correlations is stronger in a recession period than in a booming period.

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File URL: http://www.econ.kyoto-u.ac.jp/projectcenter/Paper/e-14-002.pdf
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Paper provided by Graduate School of Economics Project Center, Kyoto University in its series Discussion papers with number e-14-002.

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Length: 30 pages
Date of creation: Apr 2014
Date of revision:
Handle: RePEc:kue:dpaper:e-14-002
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  1. Bekaert, Geert & Hodrick, Robert J. & Zhang, Xiaoyan, 2005. "International Stock Return Comovements," Working Papers 06-3, University of Pennsylvania, Wharton School, Weiss Center.
  2. Wiliam Branch & George W. Evans, . "Asset Return Dynamics and Learning," University of Oregon Economics Department Working Papers 2006-14, University of Oregon Economics Department.
  3. Fran├žois Longin, 2001. "Extreme Correlation of International Equity Markets," Journal of Finance, American Finance Association, vol. 56(2), pages 649-676, 04.
  4. Timmermann, Allan, 2000. "Moments of Markov switching models," Journal of Econometrics, Elsevier, vol. 96(1), pages 75-111, May.
  5. Andrew Ang & Geert Bekaert, 2002. "International Asset Allocation With Regime Shifts," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1137-1187.
  6. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  7. Pettenuzzo, Davide & Timmermann, Allan, 2011. "Predictability of stock returns and asset allocation under structural breaks," Journal of Econometrics, Elsevier, vol. 164(1), pages 60-78, September.
  8. Okimoto, Tatsuyoshi, 2008. "New Evidence of Asymmetric Dependence Structures in International Equity Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 43(03), pages 787-815, September.
  9. Andrea Buraschi & Paolo Porchia & Fabio Trojani, 2010. "Correlation Risk and Optimal Portfolio Choice," Journal of Finance, American Finance Association, vol. 65(1), pages 393-420, 02.
  10. Kim, C-J., 1991. "Dynamic Linear Models with Markov-Switching," Papers 91-8, York (Canada) - Department of Economics.
  11. Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70.
  12. Ramchand, Latha & Susmel, Raul, 1998. "Volatility and cross correlation across major stock markets," Journal of Empirical Finance, Elsevier, vol. 5(4), pages 397-416, October.
  13. Joost Driessen & Pascal J. Maenhout & Grigory Vilkov, 2009. "The Price of Correlation Risk: Evidence from Equity Options," Journal of Finance, American Finance Association, vol. 64(3), pages 1377-1406, 06.
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