Does the correlation amongst stocks rise when stock values decline?

Question

Is there any research on whether the correlations among stocks rise when stock indices decline? Which model could account and test for that effect ? Maybe GARCH-BEKK, or some models using copulas?

Answer 1

You will probably be interested in the following papers:

• Ang & Chen: Asymmetric Correlations of Equity Portfolios

• Longin & Solnik: Extreme Correlation of International Equity Markets

• Hong et al: Asymmetric Correlation of Stock Returns: Statistical Tests and Economic Evaluation

The last paper goes further into exploring the implications of asymmetric correlation on portfolio selection and investor utility.

As you mention, GARCH-based methods like BEKK or DCC can address time-varying correlation and copulas are a good way to capture asymmetric dependence more generally.