Friday, August 08, 2008

Tracking Themes Among Asset Classes With Rolling Correlations

One way I like to track themes in financial markets is by tracking rolling correlations. These can be correlations among stock sectors/indexes or between equities and other asset classes.

Here are a few correlations of daily returns since June that caught my eye:

S&P 500 Index (SPY) and rising U.S. Dollar (UUP): .58
Rising U.S. Dollar (UUP) and Commodities (DBC): -.53
S&P 500 Index (SPY) and long-term Treasury bond prices (TLT): -.56

When we've seen a rising dollar and weak commodities, that's been associated with rising stock market prices (which we clearly saw today). When we've seen money pour into Treasury instruments (a common flight to safety trade), that's been associated with falling stock market prices.

As traders and portfolio managers place their bets on global inflation and recession, we can track their views in the movements of these and other instruments and asset classes. These movements can be tracked in the waxing and waning of rolling correlations. More on this theme to come.
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4 comments:

IDkit aka Ana said...

Brett

As 8-08-08 dawned on us, it is the start of the Olympic Games in Beijing.

I quote from Sentimentrader:

The Olympic Games is a natural time to feel a swelling of pride for your country, but that hasn't translated to the same feeling for equities. However, there are some interesting patterns that individual stocks showed during previous Games that might be useful going forward.

..............
In some of the widely-watched matches, a victory can spur an entire nation to feel better about itself, at least for a time. These are feelings that often bleed over to other walks of life, and during the Games it feels like the world is a more peaceful place and good things are possible.

It's no secret that emotions control a part of investment decision-making. Heck, it's even been proven that sunny days are more likely to result in a positive stock market than cloudy days are. So with all the goodwill present during the Games, perhaps stocks do better than usual? Unquote

The end of the session shows : plus 49% on the NASDAQ 100, plus 18% on the S&P 500 and plus 13% on the DJI.

A correlation by chance?

misko said...

Bret,
Thanks for all good work.
Can you elaborate more on calculations of rolling correlation in this article?

Thanks,

misko

Brett Steenbarger, Ph.D. said...

Hi Misko,

I simply calculate correlations in returns (not raw prices) over a lookback period using the CORR function in Excel and then copy the cells down to get a moving (rolling) correlation--

Brett

Vikaash said...

Dear Brett,

Could you please explain to me how you exactly create a rolling correlation in Excel.

I need to do this for monthly stock returns from 1980 to 2008.

I just can´t figure it out. I hope you can help me with this.

Thanks,

Vikaash