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CBA, BHP, NCM, WOW pairwise correlations

Discussion in 'Trading Strategies/Systems' started by sinner, Mar 25, 2013.

  1. sinner

    sinner

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    In part due to the recent discussion about "range trading strategies" and "picking market tops", I compiled the average rolling 20day pairwise correlation for the listed stocks. Just for the sake of anyone interested I thought I would throw up the last 6 months of data in a chart as for me it was very interesting.

    Selection_060.png

    If you are curious about why I'd be looking at these sorts of numbers please read

    Re range trading:
    " Volatility Harvesting and the Importance Of Rebalancing "
    http://gestaltu.blogspot.com.au/2012/02/volatility-harvesting-and-importance-of.html

    which has a good description of "Shannons Demon" as well as an interesting chart from the paper "The Joy of Volatility" by Dempster, Evstigneev and Schenk-Hoppe.

    Re picking market tops:
    As well as this tactical allocation strategy which uses pairwise correlations of asset classes

    http://timelyportfolio.blogspot.com.au/2011/04/great-faj-article-on-statistical_6197.html

    which includes R code for the strategy described along with a backtest to 1957.
     
  2. notting

    notting

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    I can't be bothered reading the docs.
    What does it say to you? Your opinion with respect!
     
  3. chops_a_must

    chops_a_must Printing My Own Money

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    I was thinking of this today actually, but in relation to the index.

    It looks very interesting.

    Would I be right in suggesting that gold stocks are actually the move initators based on this?

    Thanks for putting this up.
     
  4. sinner

    sinner

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    Hi chops,

    Yeah, I wanted it to be as illustrative as possible so did not include the index.

    It does look like NCM is the clear leader in correlations. But I was thinking about it and decided there is something else going on here, probably something like (assuming high correlations are market bearish) NCM has been getting hit first because it's already in a downtrend. That's not to say it didn't lead as the chart clearly shows, but the reasons for the leading are less clear, I doubt they are simply "because gold stocks". Maybe in the future it'll be another sector and therefore a different ASX20 stock?

    However I do note that over the very long term gold stocks indices tend to exhibit the same effect, i.e. if you add them to a general index portfolio it smooths out the equity curve due to its uncorrelated and elevated volatility, even if the performance of the gold index is very low or negative. Somewhat similar to bonds although bonds have obviously outperformed in a secular bull.

    I would say a good takeaway from the chart is that correlation values tend to be quite persistent once they reverse off an extreme, so if you're holding an asset for its diversification benefits and the correlation starts to go up from a very low value, you know ahead of time that the diversification value is going to decrease and switch to cash or perhaps an asset where correlations are coming down off a high value.
     
  5. faddishworm

    faddishworm

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    Im quite a noob, but what happens to these correlations if BHP buys NCM?

    There are speculations about it or so I hear.
     
  6. sinner

    sinner

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    I'm assuming you're asking, would the BHP avg pairwise correlation start to look more like NCM? Well, BHP market cap is >10 times the size of NCM, so I guess that while there would be some (10% less correlation?) change, I don't imagine it would significantly change the BHP curve.
     
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