How correlations change

April 20, 2012
Paul Murphy has a good overview of RORO today: the risk-on, risk-off phenomenon whereby all assets are increasingly correlated.

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Paul Murphy has a good overview of RORO today: the risk-on, risk-off phenomenon whereby all assets are increasingly correlated. HSBC has even come up with a RORO Index, which, you won’t be surprised to hear, is going up and to the right:


HSBC’s correlation matrices are prettier. In 2005, the world of investable assets was lovely and turquoise, full of low-correlation asset classes. Today, not so much.

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What really fascinates me about these correlation matrices, however, is the rankings. Look down the left-hand side, and you’ll see the big risk-on asset classes at the top, and the big risk-off asset classes at the bottom. Here’s how the lists changed between 2005 and today:

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There are strong similarities along the general lines you’d expect: stocks are at the top, bonds are at the bottom. But the differences are fascinating — none more than the fact that the dollar has moved from being at the top of the list in 2005 to being at the bottom of the list in 2012. Right now, the dollar is the ultimate safe asset; it’s not always thought of that way.

And while there were was a cluster of currencies at the bottom of the list in 2005 — the Swiss franc, the yen, the pound — they’ve now moved up into the middle of the list, in a world where pretty much every currency in the world has zero interest rates. The carry trade, at least between developed-world hard currencies, ain’t what it used to be.

Meanwhile, the VIX, which was right at the bottom of the list in 2005, is there no longer. It’s still used to hedge against downside volatility. But over the past seven years it has become much more of a traded asset class in its own right, and so while it used to have really strong negative correlation with, say, the Nasdaq, it doesn’t any more.

All of which is to say that correlation itself is not a simple risk-on, risk-off thing. In general, correlations rise as the RORO index goes up. But specific correlations can change in unpredictable ways. Sterling and natural gas might be among the few relatively uncorrelated asset classes today. But there’s no reason to believe they’ll stay that way tomorrow.


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