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

Authors: Donald Lien¹; Riza Demirer²

Source: Applied Financial Economics, Volume 14, Number 6, 15 March 2004 , pp. 447-456(10)

Publisher: Routledge, part of the Taylor & Francis Group

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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.

Document Type: Research article

DOI: http://dx.doi.org/10.1080/09603100410001673685

Affiliations: 1: Department of Economics University of Texas at San Antonio 6900 North Loop 1604 West San Antonio TX 78249-0633 USA 2: Department of Economics and Finance Southern Illinois University - Edwardsville School of Business Alumni Hall Edwardsville IL 62026-1102 USA

Publication date: 2004-03-15

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