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Diversification Meltdown or the Impact of Fat tails on Conditional Correlation?

  • Rachel Campbell
  • Catherine S. Forbes


  • Kees Koedijk
  • Paul Kofman

A perceived increase in correlation during turbulent market conditions implies a reduction in the benefits arising from portfolio diversification. Unfortunately, it is exactly then that these benefits are most needed. To determine whether diversification truly breaks down, we investigate the robustness of a popular conditional correlation estimator against alternative distributional assumptions. Analytical results show that the apparent meltdown in the benefits from diversification could be a consequence of assuming normally distributed returns. A more realistic assumption - the bivariate Student-t distribution - suggests that constant correlation may be sustained over the full support of the multivariate return distribution

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Paper provided by Monash University, Department of Econometrics and Business Statistics in its series Monash Econometrics and Business Statistics Working Papers with number 18/03.

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Length: 33 pages
Date of creation: Nov 2003
Date of revision:
Handle: RePEc:msh:ebswps:2003-18
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