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Quantifying the behavior of stock correlations under market stress
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Preis, Tobias, Kenett, Dror Y., Stanley, H. Eugene, Helbing, Dirk and Ben-Jacob, E. (2012) Quantifying the behavior of stock correlations under market stress. Scientific Reports, Vol.2 . Article no. 752. doi:10.1038/srep00752
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WRAP_Preis_Quantifying_behavior_srep00752.pdf - Published Version Available under License Creative Commons Attribution No Derivatives. Download (1024Kb) | Preview |
Official URL: http://dx.doi.org/10.1038/srep00752
Abstract
Understanding correlations in complex systems is crucial in the face of turbulence, such as the ongoing financial crisis. However, in complex systems, such as financial systems, correlations are not constant but instead vary in time. Here we address the question of quantifying state-dependent correlations in stock markets. Reliable estimates of correlations are absolutely necessary to protect a portfolio. We analyze 72 years of daily closing prices of the 30 stocks forming the Dow Jones Industrial Average (DJIA). We find the striking result that the average correlation among these stocks scales linearly with market stress reflected by normalized DJIA index returns on various time scales. Consequently, the diversification effect which should protect a portfolio melts away in times of market losses, just when it would most urgently be needed. Our empirical analysis is consistent with the interesting possibility that one could anticipate diversification breakdowns, guiding the design of protected portfolios.
| Item Type: | Journal Article | ||||
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| Subjects: | H Social Sciences > HB Economic Theory | ||||
| Divisions: | Faculty of Social Sciences > Warwick Business School > Behavioural Science | ||||
| Library of Congress Subject Headings (LCSH): | System analysis, Stock exchanges -- Econometric models, Dow Jones industrial average | ||||
| Journal or Publication Title: | Scientific Reports | ||||
| Publisher: | Nature Publishing Group | ||||
| ISSN: | 2045-2322 | ||||
| Official Date: | October 2012 | ||||
| Dates: |
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| Volume: | Vol.2 | ||||
| Page Range: | Article no. 752 | ||||
| DOI: | 10.1038/srep00752 | ||||
| Status: | Peer Reviewed | ||||
| Publication Status: | Published | ||||
| Access rights to Published version: | Open Access | ||||
| Funder: | Deutsche Forschungsgemeinschaft (DFG), National Science Foundation (U.S.) (NSF), Tauber Family Foundation, Universiṭat Tel-Aviv. Maguy-Glass Chair in the Physics of Complex Systems, National Business Center (U.S.) | ||||
| Grant number: | PR 1305/1-1 (DFG), D12PC00285 (NBC) |
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