I remember on Sample #2, someone said something like “during international crises, correlations increase, negating emerging markets’ investment benefits”, and the answer says his statement is correct. Huh? I thought correlations during crises may appear to increase, but that’s only the manifestation of increasing volatility, but not increase in true correlations. Your thoughts?
The CFA material bought up the counter argument of increasing volatility rather than increasing correlation, but from what I’ve seen in the practice problems they don’t seem to give that argument any weight. I’d just take it as fact that correlations increase for the sake of the test.
There is a LOS “Critique the Traditional Case against International Diversification” in Reading 28, in which we are supposed to counter the “increased correlation” argument with “no, it’s only increased volatility.” Springwater – I’m not sure if I follow you. But are you saying for the sake of the exam, we should stick to “yes correlations do increase”?
I’m saying that the literature seems to be a little contradictory on this subject. It looks like increased volatility is a critique of the increased correlation argument, but based on the practice problem we saw: “I remember on Sample #2, someone said something like “during international crises, correlations increase, negating emerging markets’ investment benefits”, and the answer says his statement is correct.” it almost appears that the increasing volatility critique is ignored. So to be safe for the exam, I’ll ignore it too and take the increasing correlations argument as law. But, if we are asked for any critiques of increasing correlations then I guess it’d be safe to offer up the increasing volatilities argument.
Got you. Thanks! There is the right way, the wrong way, and the CFAI way.
I actually think it’s both in periods of crisis emerging markets show increased correlation to develped markets because 1.economic effects, like capital outflows, decrease in trade etc. 2. a statistical effect created by increased volatility