Stefan Erdorf
Ph.D. Student, University of Cologne, Germany.
Nicolas Heinrichs
Ph.D. Student, University of Cologne, Germany.Co-movement of Fundaments:
Structural Changes in the Business Cycle
The co-movement of stocks and of fundamentals changes across the
business cycle. Empirical studies have shown that the correlation of
stock returns is stronger in crisis. We show that the correlation of
fundamentals is the highest during crisis using a large sample of
quarterly firm revenues aggregated to industry data from 1969 to 2009.
Fundamentals drive the expectation of market participants on stock and
bond prices. Structural changes in correlation of fundamentals therefore
have implications on diversification decisions in equity portfolio
analysis and credit risk management. The higher correlation in times of
crisis increases the downside risk and the bankruptcy probability of a
portfolio. Both correlations between industries and the aggregate
market and correlations between earnings confirm our findings.