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Firm-level return dispersion and correlation asymmetry: challenges for portfolio diversification

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  • Riza Demirer
  • Donald Lien

Abstract

The main purpose of this article is to study whether firm-level return dispersions might have any significance in explaining asymmetric return correlations observed in equity market returns. Correlation asymmetry, in particular increased return correlations conditional on downside moves, implies that portfolio diversification will not be as successful during bear markets - periods during which portfolio diversification will be most needed. Similarly, low firm-level return dispersion imply that stocks within the portfolio behave the same way, making diversification harder. It is found that asymmetric correlations are associated with asymmetric firm-level return dispersions. The results indicate that portfolio managers need to not only take into account the asymmetry in return correlations but also be aware of how firm-level return dispersions behave during such periods when they need diversification most.

Suggested Citation

  • Riza Demirer & Donald Lien, 2004. "Firm-level return dispersion and correlation asymmetry: challenges for portfolio diversification," Applied Financial Economics, Taylor & Francis Journals, vol. 14(6), pages 447-456.
    • Handle: RePEc:taf:apfiec:v:14:y:2004:i:6:p:447-456
    DOI: 10.1080/09603100410001673685
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    References listed on IDEAS

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    1. John Y. Campbell & Martin Lettau & Burton G. Malkiel & Yexiao Xu, 2001. "Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk," Journal of Finance, American Finance Association, vol. 56(1), pages 1-43, February.
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    Cited by:

    1. Linyu Cao & Ruili Sun & Tiefeng Ma & Conan Liu, 2023. "On Asymmetric Correlations and Their Applications in Financial Markets," JRFM, MDPI, vol. 16(3), pages 1-18, March.
    2. Stavros Degiannakis & Andreas Andrikopoulos & Timotheos Angelidis & Christos Floros, 2013. "Return dispersion, stock market liquidity and aggregate economic activity," Working Papers 166, Bank of Greece.
    3. Joëts, Marc, 2014. "Energy price transmissions during extreme movements," Economic Modelling, Elsevier, vol. 40(C), pages 392-399.
    4. repec:ipg:wpaper:28 is not listed on IDEAS
    5. repec:ipg:wpaper:2013-028 is not listed on IDEAS

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