Conditional correlation

CFA Level III Portfolio Management
#1

hi, Can anyone explain conditional correlation and its usage please

Thanks

#2

I think the gist of it is simply that correlation changes based on conditions, i.e. in a downturn, correlations will rise, defeating the purpose of your diversified portfolio, so it is important to consider conditioning effects. I’m sure someone will have more to add

#3

Yeah, the part about during a crisis markets where correlations were low will approah 1 reducing diversification benefits. Something you have to keep in mind. There is more but I can’t remember it.

#4

2014 had this question of-the correlations provided reflect normal market conditions,

Merabet believes the use of conditional return correlations is valuable in stress testing.

Support with oen reason- merabets belief about use of conditional returns correlations.

My premise is -given that in crisis -correlations dont reflect market conditions- I could not understand how it has a usage

I was of the view that for emerging markets during crisis ordinary correlations are not good enough.

but that doesnt throw light on benefit of conditional correlation.

Thanks

#5

The fact is that do reflect extreme market conditions. Thus historical correlations (which don’t reflect current market conditions) underestimate the volatility of asset class. This is especially issue during emerging market contagions.

#6

Nice Flashback - thats what we were missing and would have cost us the points - “underestimate volatility”

#7

so the benefit is we are taking the extreme conditions correlations-Thanks Flashback

#8

Yep. Volatility underestimation using just the historical correlation is the key word. You are both welcome.