The role of correlation dynamics in sector allocation

Kalotychou, E., Staikouras, S. & Zhao, G. (2014). The role of correlation dynamics in sector allocation. Journal of Banking & Finance, 48, pp. 1-12. doi: 10.1016/j.jbankfin.2014.06.025

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This paper assesses the economic value of modeling conditional correlations for mean–variance portfolio optimization. Using sector returns in three major markets we show that the predictability of models describing empirical regularities in correlations such as time-variation, asymmetry and structural breaks leads to significant performance gains over the static covariance strategy. Investors would be willing to pay a fee of up to 983 basis points to switch from the static to the dynamic correlation portfolio and about 100 basis points more for capturing asymmetries and shifts in correlations. The gains are robust to the crisis, transaction costs and are most pronounced for monthly rebalancing.

Item Type: Article
Additional Information: Copyright Elsevier 2016. Available under Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International Licence.
Uncontrolled Keywords: Correlation timing; Asymmetry; Structural break; Portfolio performance; Transaction costs
Subjects: H Social Sciences > HG Finance
Divisions: Cass Business School > Faculty of Finance

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