Stock Return Correlation Simulation to Calculate the Diversification Potential Index for a Set of Assets
The correlation between the financial asset returns changes over time. The paper introduces the concept of the diversification potential of a given set of assets. Unlike the existing approaches to evaluating the dynamics of volatility at the macro level based on market indices, this concept determines the relative importance of the overall macroeconomic conditions of operation on the market in general or in a sector in particular compared to private investment properties of different assets under consideration. A method was developed and applied for calculating the Diversification Potential Index for market industries or the market as a whole based on the dynamics of pairwise assets correlation coefficients. It uses realized quadratic covariation (correlation) models, DCC, MEWMA, OGARCH. The approaches to modeling the dynamics of Diversification Potential Index are proposed. The superiority of the HAR-RC and ARIMA model family is demonstrated in this regard.