BERND PAPE Asset Allocation, Multivariate Position Based Trading ...

ACTA WASAENSIA 31One should keep in mind, however, that the leverage effect appears to be small in sizedespite its statistical significance 34 . Furthermore it appears for the most extreme pricemovements only and is further attenuated by conditioning on trading volume 35 . Inthe light of such findings one might well be tempted to ask, whether there is mucheconomical significance to the leverage effect at all 36 .2.9.2 Correlation BreakdownSeveral studies find an increase of cross-correlations between equity returns in bearmarkets, which is commonly refered to as Correlation Breakdown. For example, King &Wadhwani (1990) and Lee & Kim (1993) find a significant increase in cross-correlationsbetween the returns of several major stock indices after the October 1987 stock marketcrash. Erb, Harvey & Viskanta (1994) report higher correlations between the stockmarket returns of the G7-countries during recessionsthaningrowthperiods. Arelatedeffect is the increase of cross-market correlations during periods of high volatility asoriginally noted by Erb et al. (1994) and Longin & Solnik (1995) and recently confirmedby Ang & Bekaert (2002) and Das & Uppal (2004) 37 .Early studies suffered, however, from a flawed interpretation of correlation matricesconditioned on large versus small absolute ex post returns: Boyer, Gibson & Loretan(1999) show that correlations conditioned on threshold returns in only one of the seriesare biased upwards. Forbes & Rigobon (2002) use this insight to show that correlationbreakdowns observed during the 1987 Stock Market Crash and other crises were onlyspurious, that is consistent with a constant unconditional correlation matrix betweenstock market returns. Loretan & English (2000) arrive at similar conclusions after investigatingamong others correlation breakdowns between the British FTSE-100 indexand the German DAX index in the time period 1991—99.34 see Tauchen et al. (1996) and Andersen, Bollerslev, Diebold & Ebens (2001).35 see Gallant et al. (1992, 1993).36 For example, Bouchaud et al. (2001) deny such significance.37 The correlation increases during bear and volatilte markets are linked by the leverage effect, sincethe largest market moves tend to be declines, see e.g. Chen, Hong & Stein (2001).