Title: Limited information-processing capacity and asymmetric stock correlations
Journal Title: Quantitative Finance
Volume: pages 1-9
Issue: pages 1-9
Publication Date: pages 1-9
Start Page: pages1-9
End Page: pages1-9
a Girne American University, North Cyprus.
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.
Accepted: 9 May 2013
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