Welcome to Scribd, the world's digital library. Read, publish, and share books and documents. See more
Download
Standard view
Full view
of .
Look up keyword
Like this
2Activity
0 of .
Results for:
No results containing your search query
P. 1
Quantifying the Behavior of Stock CORRELATIONS UNDER MARKET STRESS

Quantifying the Behavior of Stock CORRELATIONS UNDER MARKET STRESS

Ratings: (0)|Views: 8|Likes:
Published by wlannes

More info:

Published by: wlannes on Jan 15, 2013
Copyright:Attribution Non-commercial

Availability:

Read on Scribd mobile: iPhone, iPad and Android.
download as PDF, TXT or read online from Scribd
See more
See less

02/18/2015

pdf

text

original

 
Quantifying the Behavior of StockCorrelations Under Market Stress
Tobias Preis
1,2,3
, Dror Y. Kenett 
2,4
, H. Eugene Stanley 
2
, Dirk Helbing
5
& Eshel Ben-Jacob
4
1
WarwickBusiness School, University ofWarwick, Coventry,CV4 7AL, United Kingdom,
2
Center forPolymer Studies,Departmentof Physics, Boston University, Boston, MA 02215, USA,
3
Department of Mathematics, University College London, London, WC1E6BT, UK,
4
School of Physics and Astronomy, Tel-Aviv University, Tel-Aviv 69978, Israel and,
5
Chair of Sociology, in particular of Modeling and Simulation, ETH Zurich, 8092 Zurich, Switzerland.
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 butinstead 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 thestriking result that the averagecorrelation among these stocks scales linearly with market stress reflected by normalizedDJIAindexreturnsonvarioustimescales.Consequently,thediversificationeffectwhichshouldprotect a portfolio melts away in times of market losses, just when it would most urgently be needed. Ourempirical analysis is consistent with the interesting possibility that one could anticipate diversificationbreakdowns, guiding the design of protected portfolios.
 W 
ild fluctuations in stock prices
1–8
continue to have a huge impact on the world economy and thepersonalfortunesofmillions,sheddinglightonthecomplexnatureoffinancialandeconomicsystems.For these systems, a truly gargantuan amount of pre-existing precise financial market data
9–11
com-plemented by new big data ressources
12–15
is available for analyses.The complex mechanisms of financial market moves can lead to sudden trend switches
16–18
in a number of stocks. Such sudden trend switches can occur in a synchronized fashion, in a large number of stocks simulta-neously, or in an unsynchronized fashion, affecting only a few stocks at the same time.Diversificationinstockmarketsreferstothereductionofportfolioriskcausedbytheinvestmentinavarietyof stocks. If stock prices do not move up and down in perfect synchrony, a diversified portfolio will have less risk than the weighted average risk of its constituent stocks
19,20
. Hence it should be possible to reduce risk in price of individual stocks by the combination of an appropriate set of stocks. To identify such anappropriate setof stockswith anti-correlated price time series, the assumption mostly used is that the correlations among stocks areconstant over time
21–26
. This widely used assumption is also the basis for the determination of capital require-ments of financial institutions that usually own a huge variety of constituents belonging to different asset classes.Recentstudiesbuildingontheavailabilityofhugeanddetaileddatasetsoffinancialmarketshaveanalyzedandmodeled the static and dynamic behavior of this very complex system
27–39
, suggesting that financial markets aregoverned by systemic shifts and display non-equilibrium properties.A very well known stylized fact of financial marketsis the
leverage effect 
, a term coined by Black to describe thenegative correlation between past price returns and future realized volatilities in stock markets. According toReigneron
et al.
40
, the index leverage effect can be decomposed into a volatility effect and a correlation effect. Inthe course of recent financial market crises, this effect has regained center stage, and the work of different groupshas focused on uncovering its true nature
40–46
). Reigneron
et al.
analyzed daily returns of six indices from 2000 to2010 and found that a downward index trends increase the average correlation between stocks, as quantified by measurements of eigenvalues of the conditional correlation matrix. They suggest that a quadratic term should beincluded to the linear regressions of the dependence of mean correlation on the index return the previous day.Here,wewillexpandontheseresultsutilizing72yearsoftradingofthe30DowJonesindustrialaverage(DJIA)components(seealso
47,48
).Usingthisfinancialdatasetwewillquantifystate-dependentstockmarketcorrelationsand analyze how they vary in face of dramatic market losses. In such ‘‘stress’’ scenarios, reliable correlations aremost needed to protect the value of a portfolio against losses.
SUBJECT AREAS:
STATISTICAL PHYSICS,THERMODYNAMICS ANDNONLINEAR DYNAMICSPHYSICSINFORMATION THEORY ANDCOMPUTATIONSTATISTICS
Received29 June 2012 Accepted25 September 2012Published18 October 2012
Correspondence andrequests for materialsshouldbeaddressedtoT.P. (mail@tobiaspreis.de)
SCIENTIFIC
REPORTS
| 2 : 752 | DOI: 10.1038/srep00752
1
 
Results
To quantify state-dependent correlations, we analyze historical daily closing prices of the
;
30 components of the DJIA over 72 years,from 15 March 1939 until 31 December 2010, which can be down-loaded as a
Supplementary Dataset 
. During these
;
18596 trading days, various adjustments of the DJIA occurred. We explicitly con-sider an adjustment of the index when one of the 30 stocks isremoved from the index and replaced by a new stock in order toensure that we accurately reproduce the index value of the DJIA ateach trading day (Fig. 1).To calculate the official index value
p
DJIA
, the sum of prices of all30 stocks is divided by a normalization factor
DJIA
, known as theDJIA divisor. The DJIA divisor anticipates index jumps caused by effects of stock splits, bonus issues, dividends payouts or replace-ments of individual index components keeping the index value con-sistent(Fig.1A).Consequently,theindexvalueoftheDJIAatday 
isgiven by 
 p
DJIA
ð Þ
~
P
i
~
1
 p
i
ð Þ
DJIA
,
ð
1
Þ
where
p
i
(
) reflects the price of DJIA component
i
at day 
in units of 
USD
and where
is measured in units of trading days. The normal-ization factor
DJIA
is also measured in units of 
USD
. Consequently,the value of the DJIA is dimensionless. Due to changes in the com-ponentsoftheDJIA,acomponent
i
doesnotnecessarilyreflectpricesof one stock only. A subscript
i
is also used for a component’s pre-decessor or successor.To quantify state-dependent correlations, we calculate the mean value of Pearson product-moment correlation coefficients
49
among all DJIA components in a time interval comprising 
D
trading dayseach (Fig. 2). In each time interval comprising 
D
trading day, wedeterminecorrelationcoefficientsforallpairsof 
;
30stocks.Fromthese correlation coefficients, we calculate their mean value for eachtime interval separately.We relate mean correlation coefficients to corresponding marketstates, which we quantify by DJIA index returns for time intervalsstarting at trading day 
and ending at trading day 
1
D
,
DJIA
,
D
ð Þ
~
log 
p
DJIA
z
D
ð Þð Þ
log 
p
DJIA
ð Þð Þ
:
ð
2
Þ
We normalize the time series of DJIA index returns,
DJIA
(
,
D
), by its standard deviation,
s
DJIA
(
D
), defined as
s
DJIA
D
ð Þ
:
 ffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
1
X
~
1
DJIA
ð Þ
2
{
1
X
~
1
DJIA
ð Þ
!
2
uut
:
ð
3
Þ
    D    J    I    A    D    i   v    i   s   o   r    (    U    S    D    )
051015
   3  0   A   U   G    1   9   8   2   1   2    M  A   R    1   9   8   7  0   1    J   U   N    1   9   5   9   2   9    J   U   N    1   9   7   9  0   9   A   U   G    1   9   7  6   3  0    O   C    T    1   9   8   5  0   3    J   U   L    1   9   5  6  0  6    M  A    Y    1   9   9   1   1   7    M  A   R    1   9   9   7  0   1    N   O    V    1   9   9   9  0   8   A   P   R    2  0  0  4   1   9    F   E   B    2  0  0   8  0   8    J   U   N    2  0  0   9   1  4    M  A   R    1   9   3   9
Date
AAAXPBACATDDDISGEHDHWP / HPQIBMINTCJNJJPMKOMCDMMMMRKMSFTPGUTXWMTJ / XON / XOMGMCSCOTRVTRV / CCI / CKFTBACMOCVXACD / ALD / HONSBC / TAIGTPFEEKVZIPSGTSD / CHVUKWXTXBSZHR / NAVX / MROAC / PAOINGFAT / AMBJM / MANCSWX / ESMADRARCFGNSL
AB
    D    J    I    A    C   o   m   p   o   n   e   n   t   s
Figure 1
|
Index components of the Dow Jones Industrial Average (DJIA).
(
A
) To calculate the index value of the DJIA, we determine the sum of pricesof all 30 stocks belonging to the index and divide them by the depicted ‘‘DJIA Divisor’’. Adjustments of this divisor ensure that various corporate actionssuch as stock splits do not affect the index value. (
) We analyze DJIA values and prices of all index components for 72 years from March 15, 1939 untilDecember31,2010.Verticaldashedlinescorrespondtoeventsinwhichatleastonestockwasremovedfromtheindexandreplacedbyanotherstock.Theindex changes are explicitly taken into account to ensure that the dataset, comprising 18,596 trading days, accurately reflects all 30 daily closing pricesneeded for the index calculation. We use current and historical ticker symbols to abbreviate company names
50
.
 www.nature.com/
scientificreports
SCIENTIFIC
REPORTS
| 2 : 752 | DOI: 10.1038/srep00752
2
 
ThenormalizedtimeseriesofDJIAindexreturns,
R
(
,
D
),isgivenby 
R
,
D
ð Þ
~
DJIA
,
D
ð Þ
{
1
X
~
1
DJIA
ð Þ
s
DJIA
D
ð Þ
:
ð
4
Þ
In each time interval comprising 
D
trading days, we calculate a localcorrelation matrix consisting of Pearson correlation coefficients
49
capturing the dependencies among individual stock returns. Time-dependent returns of an individual stock 
i
are given by 
i
ð Þ
~
log 
p
i
z
1
ð Þð Þ
log 
p
i
ð Þð Þ
:
ð
5
Þ
In a
D
trading day interval, we calculate a correlation coefficientbetween return time series of stock 
i
and return time series of stock 
j
by 
i
,
 j
,
D
ð Þ
~
D
P
z
D
{
1
t
~
i
t
ð Þ
 j
t
ð Þ
{
P
z
D
{
1
t
~
i
t
ð Þ
P
z
D
{
1
t
~
 j
t
ð Þ
D
2
s
i
,
D
ð Þ
s
 j
,
D
ð Þð
6
Þ
with the standard deviation of return time series
i
determined in thesame time interval comprising 
D
trading days defined as
s
i
,
D
ð Þ
:
 ffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
1
D
X
z
D
{
1
t
~
i
t
ð Þ
2
{
1
D
X
z
D
{
1
t
~
i
t
ð Þ
!
2
:
uut
ð
7
Þ
The mean correlation coefficient of all DJIA components is given by the mean of all non-diagonal matrix elements of 
i,j
C
,
D
ð Þ
~
1
N
{
1
ð Þ
X
i
,
 j
,
i
=
 j
i
,
 j
,
D
ð Þ ð
8
Þ
Figure 2
|
Visualization of the analysis method.
(
A
) For a time interval of 
D
trading days, we calculate for the index the price return log(
 p 
DJIA
(
1
D
))/log(
 p 
DJIA
(
)) in this interval. (
) We determine the Pearson correlation coefficients of all pairs of all 30 DJIA components depicted in a matrix of correlationcoefficients.Tickersymbolsareusedtoabbreviatecompanynamesinthisexample.Wecalculatethemeancorrelationcoefficientbyaveragingover all non-diagonal elements of this matrix.
    M   e   a   n    C   o   r   r   e    l   a   t    i   o   n ,
       C
0.30.40.50.62.52.01.51.00.50.00.51.01.52.02.5
t=10 Dayst=20 Dayst=30 Dayst=40 Dayst=50 Dayst=60 Days
Normalized DJIA Return,
R
[Standard Deviations]
    R   e   t   u   r   n ,
       R
−10−505
 Time [Trading Days]
    C   o   r   r   e    l   a   t    i   o   n ,
       C
0.00.20.40.60.80 2000 6000 10000 14000 18000
A B
Figure 3
|
Quantificationofstate-dependentcorrelationsamongindexcomponents.
(
A
)Graphsreflecttherelationshipbetweentheaveragecorrelationcoefficient
amongstocks belongingtotheDowJonesIndustrialAverageanditsnormalizedreturninintervalsof 
D
tradingdays.Themeancorrelationcoefficient showsa striking,non-constant behavior,withaminimum between 0and
1
1standard deviations reflectingtypical market conditions. For therange of all
D
values analyzed, we find the data collapse onto a single line. Corresponding error bars are shown in Fig. 4A. The data collapse suggests thatthestrikingincreaseofthemeancorrelationcoefficientforpositiveandnegativevaluesofthenormalizedindexreturnisindependentofthetimeinterval
D
. The largest mean correlation coefficients coincide with the most negative index returns. (
) Normalized DJIA returns,
(
,
D
), and mean correlationcoefficients,
(
,
D
), shown for
D
5
10 days. For both time series, we reject the null hypothesis of non-stationarity on the basis of results from theAugmented Dickey-Fuller test. For
(
,
D
5
10), we obtain
DF 
52
24.28,
,
0.01, while for
(
,
D
5
10) we obtain
DF 
52
13.45,
,
0.01.
 www.nature.com/
scientificreports
SCIENTIFIC
REPORTS
| 2 : 752 | DOI: 10.1038/srep00752
3

You're Reading a Free Preview

Download
scribd
/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->