Ignore Shifting Correlations At Your Peril

September 24, 2014

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Not surprisingly, higher correlation levels between stocks and bonds will lead to higher volatility levels for the same asset allocation.

But how does the correlation regime come into play when it comes to flight to safety?

In the scatter charts below, we plot daily stock and corresponding bond returns. We split the data into the two long-dated correlation regimes to see if the average correlation has an impact on short-cycle flight to safety. If bonds serve as a good hedge, we expect to see more points in the top-left quadrant than in the bottom-left.

 

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