TITLE

The Volatility of Correlation

AUTHOR(S)
Coaker II, William J.
PUB. DATE
February 2006
SOURCE
Journal of Financial Planning;Feb2006, Vol. 19 Issue 2, p58
SOURCE TYPE
Academic Journal
DOC. TYPE
Article
ABSTRACT
• The severity of how much correlation changes, even over longer periods of time, has not been adequately understood. • This paper analyzes the changing correlation of 15 asset classes measured against the S&P 500 over a 35-year period, and the impact of those changes on asset allocation decisions. It measures the correlations in rolling one-, three-, five-, and ten-year time series, from 1970 to 2004. • The article also evaluates whether 15 asset classes have helped or hurt in years the S&P 500 has declined, and whether growth or value styles are more correlated to the index. • The average variance in correlation measured 0.98 over one year and 0.25 over ten years. In short the relationship among many of the asset classes appears to be inherently unstable. • Large value provides more diversification benefits than large growth, and small value provides more diversification than small blend or small growth. Emerging markets may provide higher returns and greater diversification than developed nations. But the low correlations of small value and real estate may not hold up during the next broad market decline. • Correlations exhibit uniqueness, meaning periods are distinct from previous time periods. For example, international stocks' correlation to the S&P 500 was 0.48 from 1970 to 1997, but 0.83 from 1998 to 2002. • Rather than rely on historical correlations, a more comprehensive and dynamic approach is needed in making asset allocation decisions. INSET: Executive Summary.
ACCESSION #
19617012

 

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