Discussion paper

DP3172 Increased Correlation in Bear markets: A Downside Risk Perspective

A number of studies have provided evidence of increased correlation in global financial market returns during bear markets. Others, however, have shown that some of this evidence may have been biased. We derive an alternative estimator for implied correlation based on portfolio downside risk measures that does not suffer from this bias. These unbiased quantile correlation estimates are directly applicable to portfolio optimization and to risk management techniques in general. This simple and practical approach captures the increasing correlation in extreme market conditions while providing a pragmatic approach to understanding correlation structure in multivariate return distributions. Based on data for international equity markets we find evidence of significant increased correlation in extreme returns in international equity markets. This proves the importance of providing a tail adjusted mean-variance covariance matrix.


Kofman, P, K Koedijk and R Campbell (2002), ‘DP3172 Increased Correlation in Bear markets: A Downside Risk Perspective‘, CEPR Discussion Paper No. 3172. CEPR Press, Paris & London. https://cepr.org/publications/dp3172