[R-sig-finance] structural breaks in correlation

[Patrick Burns]

Another way to look at changes in correlation is
via multivariate GARCH models.  In my experience
they tend not to support the idea of structural breaks.
(But then they are presuming that there are no breaks.)

Patrick Burns
patrick at burns-stat.com
+44 (0)20 8525 0696
http://www.burns-stat.com
(home of S Poetry and "A Guide for the Unwilling S User")

Achim Zeileis wrote:

>On Wed, 22 Mar 2006 22:24:51 -0500 Krishna Kumar wrote:
>
>  
>
>>Hi folks,
>>
>>I am trying to understand structural breaks in correlation using the 
>>strucchange package in R.
>>I am looking at a rolling window estimate of correlation (pearsons)
>>to identify breaks and see if the underlying process has changed.
>>
>>
>> > data(EuStockMarkets)
>> > dax <- log(EuStockMarkets[,"DAX"])
>> >  ftse <- log(EuStockMarkets[,"FTSE"])
>> > dax.ret<-diff(dax)
>> > ftse.ret<-diff(ftse)
>>
>>rollingcor <- function(ret, width) {
>>T<-dim(ret)[1]
>>results<-1:(T-width)
>>     for (i in 1:(T-width)) {
>>    indx<-i+width
>>        results[i] <- cor(ret[i:indx,1],ret[i:indx,2] )
>>     }
>>     return(results)
>>   }
>>
>> >dax.ftse.cor<-rollingcor(cbind(dax.ret,ftse.ret),50)
>>    
>>
>
>You can compute this quantity much easier via:
>  dax.ftse.cor <- rapply(diff(log(EuStockMarkets[,c("DAX", "FTSE")])),
>    50, function(x) cor(x[,1], x[,2]), by.column = FALSE)
>
>  
>
>> > ordcus<-efp(dax.ftse.cor~1,type="OLS-CUSUM")
>> > plot(ordcus)
>>
>>Is this the right way to test a rolling correlation estimate? And are 
>>there other tests that are recommended besides the cusum test?
>>    
>>
>
>I would not use the strategy above, because you introduce a(n
>additional) dependence into the series by computing the correlations
>beforehand. Instead you could simply use a regression model, e.g.
>  dax <- diff(log(EuStockMarkets[,"DAX"]))
>  ftse <- diff(log(EuStockMarkets[,"FTSE"]))
>and use a moving estimates test in this regression model, e.g., with a
>bandwidth of 10% of the data
>  me <- efp(dax ~ ftse, type = "ME", h = 0.1)  
>  plot(me, functional = NULL)
>which would suggest a shift between 1992-1993 and 1997-1998. Other
>tests, not only moving estimates tests would yield similar results, for
>example a CUSUM-type test based on the model scores
>  scus <- gefp(dax ~ ftse)
>  plot(scus, aggregate = FALSE)
>For a recent survey of these and related tests, see
>  Achim Zeileis (2005). "A Unified Approach to Structural Change Tests
>  Based on ML scores, F statistics, and OLS residuals," Econometric
>  Reviews, 24(4), 445-466.
>A preprint version is available from my Web page.
>
>hth,
>Z
>
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>  
>