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
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: Suggested Citation