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FRM Part II · FRM Exam Part II · Empirical Properties of Correlation: How Do Correlations Behave in the Real World?

A portfolio manager notes that rolling 60-day correlation between two sector indices has an autocorrelation coefficient of 0.90 at a one-month lag. What is the most appropriate inference about correlation behavior?

Correlation shows strong persistence, so today's correlation is a useful predictor of near-term correlation. A 0.90 autocorrelation means shocks decay slowly, unlike white noise, which would show roughly zero autocorrelation.

  1. ACorrelation exhibits strong persistence, so current correlation is a useful predictor of near-term correlationCorrect
  2. BCorrelation is a white-noise process
  3. CCorrelation shocks reverse immediately the next month
  4. DCorrelation cannot be forecast from its own history

Explanation

A high autocorrelation indicates persistence: current levels carry over into subsequent periods. Note part of the figure can arise from overlapping windows, but the conclusion of persistence and predictive usefulness stands. White noise would show near-zero autocorrelation.

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