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Journal of Banking & Finance Vol. 48 2014

The role of correlation dynamics in sector allocation

Elena Kalotychou1,2; Sotiris K. Staikouras1,2; Gang Zhao3

1 Alba Graduate Business School, The American College of Greece · 2 City, University of London · 3 University of Bath

Abstract

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.

DOI
10.1016/j.jbankfin.2014.06.025
Volume
48
Pages
1-12
Language
en
Sources
openalex crossref bibtex:phds-export.bib

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