Abstract
In this paper, we will analyse the increase of correlations in the market during periods of crisis, given its importance to the management and optimization of the portfolio, and especially for risk diversification in portfolio management. An evaluation of the level of correlation between the stock markets is important for several reasons. First, it enables to evaluate changes in the patterns of correlation, and thus to make the proper adjustments in portfolios’ investment. Second, policy makers are also interested in these correlations because of its implications for the stability of the financial system.
 The correlation coefficients are biased measures of dependence when markets become more volatile. This paper explores the correlation of the Portuguese capital markets with the Asian, American, European and Latin American Spanish stock markets. To this end, we used the PSI-20 index, Nikkei 225, NASDAQ, S&P 500, Euronext 100 and Ibex-35. Our analysis results show that the correlation does exist as a phenomenon during financial crises (Bear Market), reducing the benefits of portfolio diversification when most needed. Moreover, we believe that correlations have increased between the markets in recent years.
Highlights
This paper aims to obtain the level of correlation of the main Portuguese stock index that has some of the highest stock indexes
We found that the correlation between returns in equity markets is strongly explained by market volatility
The major market indexes tend to be correlated, since they react more quickly and have a greater range of information. This result is consistent with empirical studies of Ang and Chen (2002) indicating that the observed increase in dependency of the phenomenon during the Bear Market is resultant from a regime of greater volatility, but not entirely
Summary
This paper aims to obtain the level of correlation of the main Portuguese stock index that has some of the highest stock indexes For this analysis, we select the index that will provide greater coverage of studies on the specificity of the actions of the stock market in Portugal. Despite the creation of the PSI-20 on December 31st we will focus our analysis over the last 10 years, i.e., from January 1st 1999 to December 31st 2008 In this period of time it is intended to analyse some of the most significant moments in the capital markets, the end of the Asian crisis (1998), the technology bubble (2000), September 11 (2001), the impact of Enron and telecommunications group Wordcom (2002) and, the recent effect of Subprime (2008). The methodology for this work follows the work Flavin, Hurley and Rousseau (2000) and Serra (2002), Knif, Pynnonen and Kolari (2005) and Short (2007)
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