Exploring the Changes in Asset Correlation Over Time
Open Access
- Author:
- Himmel, Zachary
- Area of Honors:
- Finance
- Degree:
- Bachelor of Science
- Document Type:
- Thesis
- Thesis Supervisors:
- David Haushalter, Thesis Supervisor
Brian Spangler Davis, Thesis Honors Advisor - Keywords:
- Finance
Correlation
Diversification
Portfolio Optimization - Abstract:
- This paper examines the changes in asset correlation over time to better understand the application of Portfolio Theory in the modern era. The goal of the provided research is to provide evidence that asset correlations have changed over time, not only across equities, but across fixed income securities and commodities as well. As a result of these changes, investors can make more educated decisions based on personal risk tolerances, ability to decrease portfolio variance, and investment goals. Assets classes are selected across bonds, commodities, and equities with different characteristics, such as geography, industry exposure, and purpose. Correlation is calculated for four periods of five years beginning in 2001, utilizing monthly returns. Overall, assets classes have been increasing in correlation over time, with the assets selected averaging a 2.68% increase in correlation in each period of five years. On average, equities increased the most, with correlation increasing 9.69% on average across each period of five years, with bonds decreasing in correlation on average by 4.25% for each period of five years, and commodities showing no significant changes in correlation. Between 2011 and 2016, each asset class saw the direction of correlation changes change, possibly due to drastically different foreign economic policies. The remainder of this paper serves as a case study of historical financial events throughout the past twenty years, which provide evidence to an increasingly globalized economy, which has caused more congruency in asset returns. In terms of crafting manageable strategies to average investors, it can be inferred that asset class diversification is a more effective means of lowering portfolio variance and spreading risk than investing in international equities.