Handling risk-on/risk-off dynamics with correlation regimes and correlation networks
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In this paper, we present a framework for detecting distinct correlation regimes and analyzing the emerging state dependences for a multi-asset futures portfolio from 1998 to 2013. These correlation regimes have been significantly different since the financial crisis of 2008 than they were previously; cluster tracking shows that asset classes are now less separated. We identify distinct “risk-on” and “risk-off” assets with the help of correlation networks. In addition to visualizing, we quantify these observations using suitable metrics for the clusters and correlation networks. The framework will be useful for financial risk management, portfolio construction, and asset allocation.
KeywordsRegime switching Correlation regimes Clustering Correlation networks Risk management Portfolio construction Asset allocation
JEL ClassificationC14 G11 G01 D85
We thank Frank Fabozzi and an anonymous referee for valuable comments that significantly improved the quality of this article.
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