Limited Information-Processing Capacity And Asymmetric Stock Correlations

Quantitative Finance, Vol. 15, No. 6, pp. 1031-1039, 2015

Posted: 20 Oct 2016 Last revised: 24 Oct 2016

See all articles by Ozcan Ceylan

Ozcan Ceylan

Istanbul Kemerburgaz University

Date Written: 2015

Abstract

Through an orthogonalized impulse-response analysis, I studied the relationship between the variance risk premium, market variance and stock correlations in the French stock market from September 2002 through September 2006, using high-frequency data-based measures. Variance risk premium is estimated using realized variances and index options-implied variances and used as a state vector to proxy investors perceived uncertainty. I found that a shock to variance risk premium causes long-lasting increases in the market variance pointing to the limitedness of investors information-processing capacity. At the same time, the shock generates consecutive increases in realized correlations between individual stocks and the market portfolio. I propose this as a possible explanation for the asymmetric/counter-cyclic behaviour of stock correlations.

Keywords: Realized Correlations, Variance Risk Premia, Orthogonalized Impulse-Responses, Attention Allocation

JEL Classification: D8, G14

Suggested Citation

Ceylan, Ozcan, Limited Information-Processing Capacity And Asymmetric Stock Correlations (2015). Quantitative Finance, Vol. 15, No. 6, pp. 1031-1039, 2015, Available at SSRN: https://ssrn.com/abstract=2854202

Ozcan Ceylan (Contact Author)

Istanbul Kemerburgaz University ( email )

Mahmutbey Dilmenler cad No 26
Bagcilar
Istanbul
Turkey

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