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 | Anticipating Correlations: |
Financial markets respond to information virtually instantaneously. Each new piece of information influences the prices of assets and their correlations with each other, and as the system rapidly changes, so too do correlation forecasts. This fast-evolving environment presents econometricians with the challenge of forecasting dynamic correlations, which are essential inputs to risk measurement, portfolio allocation, derivative pricing, and many other critical financial activities. In Anticipating Correlations, Nobel Prize--winning economist Robert Engle introduces an important new method for estimating correlations for large systems of assets: Dynamic Conditional Correlation (DCC). Engle demonstrates the role of correlations in financial decision making, and addresses the economic underpinnings and theoretical properties of correlations and their relation to other measures of dependence. He compares DCC with other correlation estimators such as historical correlation, exponential smoothing, and multivariate GARCH, and he presents a range of important applications of DCC. Engle presents the asymmetric model and illustrates it using a multicountry equity and bond return model. He introduces the new FACTOR DCC model that blends factor models with the DCC to produce a model with the best features of both. It allows for time variation in the factor loadings and the number of factors. This model is illustrated and tested with an array of U.S. large-cap equities. A technical chapter of econometric results is included. Based on the Econometric Institute Lectures at Erasmus University Rotterdam, Anticipating Correlations puts powerful new forecasting tools into the hands of researchers, financial analysts, risk managers, derivative quants, and graduate students. Robert Engle is the Michael Armellino Professor in the Management of Financial Services at New York University's Leonard N. Stern School of Business. His books include Cointegration, Causality, and Forecasting. He was awarded the 2003 Nobel Prize in economics. "This book offers a comprehensive and thorough discussion of the Dynamic Conditional Correlation class of models. It presents things in an easy-to-read, coherent, and unified framework, and includes new and interesting empirical findings and economic insights. Anticipating Correlations should serve as the authoritative reference for this important class of models."--Tim Bollerslev, Duke University Series:
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