Feb

1

Finance professors teach their students that diversification is the only "free lunch" they can get. Recently, I looked at eight market groups (period 1995-2014). High correlations within individual groups could be expected. More interesting is what is happening on a wider scale over time. I recall that media were writing around 2008 that the "free lunch" is gone and that all markets behave like one big correlated monster, like Dracula. Between 2007-2012 we could see increased numbers, but recently we moved back to the normal. I have attached a figure for the year 2014 (server did not allow more pictures - 100k limit; for those who are interested all data can be found here).

Ralph Vince comments: 

Correlations have NO relevance in allocation decisions — they are not only not constant, they don't address the relationship properly (as a copula does). Using the latter, one see the effect of those oddball days of immense danger, and can then craft their allocation strategy accordingly. Straight correlations tend to mask this.

Stefan Martinek replies: 

I agree Ralph. I like things balanced between equities, fixed income, currencies, and commodities. We can ignore Markowitz + half Chicago. But it is still interesting to see where we are now in comparison to history and whether things somehow degenerate.


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