Analysing correlations under stress

A structural assessment of co-variability during periods of stress can improve crisis management and contribute to better strategic planning, argues David Rowe

It is commonly recognised that correlations in a crisis vary significantly from those we observe under normal market conditions. Unfortunately, the analysis of such crisis behaviour often stops at a breezy claim that correlations all migrate to one or minus one. It certainly is true many correlations tend to shift to large absolute values in a stress situation, but this observation alone is of little value for diagnosing how a crisis might unfold. What we need to do is apply structural