Thursday, December 13, 2007

International Stock Market Correlations: A Sectoral Approach

International Stock Market Correlations: A Sectoral Approach

Fasnacht, Philipp and Louberge, Henri, (December 2007). Paris December 2007 Finance International Meeting AFFI-EUROFIDA

Abstract:
A lot of studies dealing with international correlations look only at correlations at the market level and often use its time-varying nature as motivation for their work. However, why and how market correlations change is a point that is still not very well understood. As the market is composed of different sectors, we propose to look into this question by studying the behavior of equity correlations at the sectoral level. We show how sectoral correlation coefficients determine the market correlation coefficient and decompose the latter into two parts; one that represents country factors and one that represents industry factors. This decomposition allows us to get a clear idea on how and why market correlations change over time. We also get some interesting insights such as market level correlations are higher on average than sectoral correlations as well as that sectoral correlations between countries tend to do be more stable over time than market level correlations and sectoral correlations within countries. Finally, we present evidence that a few sector correlations related to Financial, Industrial and Consumer Services segments drive the evolution of the market level correlation.

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