Correlations Among Stocks Forming The Dow Jones Industrial Average
A quantitative analysis of 72 years of financial data from the Dow Jones Industrial Average reveals that in times of financial crises, stocks start to move in a more synchronised fashion, increasing the risk of a stock portfolio. The research is published in the journal Scientific Reports. Financial traders try to reduce the inherent risk of holding only one stock by building portfolios, which carry a lower risk, mainly because individual stocks do not tend to experience daily gains and losses in a completely synchronised manner. Tobias Preis and colleagues analyzed daily closing prices of the 30 stocks that form the Dow Jones Industrial Average, from March 1939 to the end of 2010. They find that the average correlation between these stocks increases at the same rate as market stress. Consequently the diversification effect, which should protect a portfolio, melts away in times of market losses, just when it would be needed most.
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