Empirical Properties of Correlation: How Do Correlations Behave in the Real World? (FRM P2–B1–Ch8)

Learn the empirical properties of correlation for FRM Part 2 (Book 1 – Market Risk Measurement & Management). We test how correlations behave across market regimes, why they often rise in crises, and how correlation volatility, mean reversion, and autocorrelation (ARCH/GARCH) affect portfolio risk. We also compare equity vs bond vs default correlations and review best-fit distributions (KS, Anderson–Darling, Chi-square tests).

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After completing this reading you should be able to:
Describe how equity correlations and correlation volatilities behave throughout various economic states.
Calculate a mean reversion rate using standard regression and calculate the corresponding autocorrelation.
Identify the best-fit distribution for equity, bond, and default correlations.

0:00 Introduction
0:59 Learning Objectives
3:05 A Study on the Dow - Results (1/2)
8:47 Reasonable Conclusions
12:47 Mean Reversion: Statistical Definition
13:56 Quantifying the Degree of Mean Reversion (1/3)
21:26 Quantifying the Degree of Mean Reversion (3/3)
21:52 How to Estimate the Mean Reversion Rate
23:08 Regression Equation for the Dow
26:12 Deriving the Autocorrelation for a Time Lag of One Period
26:44 The Best-fit Distribution for Equity, Bond, and Default Correlations

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