Working Paper Series no. 73: Does correlation between stock returns really increase during turbulent period ?

Abstract

Correlations between international equity markets are often claimed to increase during periods of high volatility, therefore the benefits of international diversification are reduced when they are most needed, i.e. during crises. In this paper, we investigate the relationship between international correlation and stock-market turbulence. We estimate a multivariate Markov-switching model, in which the correlation matrix is allowed to vary across regimes. Subsequently, we test the null hypothesis that correlations are regime independent.\ Using weekly stock returns for the S\&P, the DAX and the FTSE over the period 1988-1999, we find that international correlations significantly increased during turbulent periods.

François Chesnay and Eric Jondeau
April 2000

Classification JEL : C53, G15.

Keywords : Stock returns, International correlation, Markov-switching model