A New Tail-Based Correlation Measure and Its Application in Global Equity Markets
The co-dependence between assets tends to increase when the market declines. This paper develops a correlation measure focusing on market declines using the expected shortfall (ES), referred to as the ES-implied correlation, to improve the existing...
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| Language: | English |
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World Bank, Washington, DC
2019
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| Online Access: | http://documents.worldbank.org/curated/en/641081547753593928/A-New-Tail-Based-Correlation-Measure-and-Its-Application-in-Global-Equity-Markets http://hdl.handle.net/10986/31177 |
| Summary: | The co-dependence between assets tends
to increase when the market declines. This paper develops a
correlation measure focusing on market declines using the
expected shortfall (ES), referred to as the ES-implied
correlation, to improve the existing value at risk
(VaR)-implied correlation. Simulations which define
period-by-period true correlations show that the ES-implied
correlation is much closer to true correlations than is the
VaR-implied correlation with respect to average bias and
root-mean-square error. More importantly, this paper
develops a series of test statistics to measure and test
correlation asymmetries, as well as to evaluate the impact
of weights on the VaR-implied correlation and the ES-implied
correlation. The test statistics indicate that the linear
correlation significantly underestimates correlations
between the US and the other G7 countries during market
downturns, and the choice of weights does not have
significant impact on the VaR-implied correlation or the
ES-implied correlation. |
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