Limited Information-Processing Capacity and Asymmetric Stock Correlations

Ceylan, Ozcan (2010): Limited Information-Processing Capacity and Asymmetric Stock Correlations. Published in: Quantitative Finance , Vol. 15, No. 6 (3 June 2015): pp. 1031-1039.

Abstract

Through an orthogonalized impulse-response analysis, I studied the relationship between the variance risk premium, market variance and stock correlations in the French stock market from September 2002 through September 2006, using high frequency data-based measures. Variance risk premium is estimated using realized variances and index options-implied variances and used as a state vector to proxy investors’ perceived uncertainty. I found that a shock to variance risk premium causes long lasting increases in the market variance pointing to the limitedness of investors’ information-processing capacity. At the same time, the shock generates consecutive increases in realized correlations between individual stocks and the market portfolio. I propose then a possible explanation for the asymmetric/counter-cyclic behavior of stock correlations.

• Item Type: MPRA Paper
• Language: English
• Keywords: Limited Attention, Asymmetric Correlations, Variance Risk Premium, High-frequency Econometrics, Impulse-Response Analysis
• Subjects: G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading

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