Correlation of financial markets in times of crisis

TL;DR

This paper analyzes how financial markets become more correlated during crises, showing that high volatility coincides with markets moving together, especially during major crashes like 1987, 2001, and 2008.

Contribution

It introduces a correlation analysis using eigenvalues and eigenvectors to demonstrate market behavior during crises, highlighting increased synchronization during downturns.

Findings

High market volatility correlates with increased market correlations.

Markets tend to behave as a single entity during major crashes.

Eigenvalue analysis reveals strong correlations during crises.

Abstract

Using the eigenvalues and eigenvectors of correlations matrices of some of the main financial market indices in the world, we show that high volatility of markets is directly linked with strong correlations between them. This means that markets tend to behave as one during great crashes. In order to do so, we investigate several financial market crises that occurred in the years 1987 (Black Monday), 1989 (Russian crisis), 2001 (Burst of the dot-com bubble and September 11), and 2008 (Subprime Mortgage Crisis), which mark some of the largest downturns of financial markets in the last three decades.