Volatility and Cross Correlation Across Major Stock Markets

We examine the relation between correlation and variance in a conditional time and state varying framework. Using a switching ARCH (SWARCH) technique we document the finding that the correlations between the U.S. and other world stock markets are on average 2 to 3.5 times higher when the U.S. market is in a high variance state as compared to a low variance regime. We also find that, compared to a GARCH framework, the portfolio choices resulting from our SWARCH model lead to higher Sharpe ratios