Is the Correlation in International Equity Returns Constant: 1960-90?

We study the correlation of monthly excess returns for seven major countries over the period 1960-1990. We find that the international covariance and correlation matrices are unstable over time. A multivariate GARCH(1,1) modelling with constant conditional correlation helps capture some of the evolution in the conditional covariance structure. We include information variables in the mean and variance equations. The volatility of markets changed somewhat over the period 1960-1990 and the proposed GARCH modelling allows to capture this evolution in variances. However tests of specific deviations lead to a rejection of the hypothesis of a constant conditional correlation. An explicit modelling of the conditional correlation indicates an increase of the international correlation between markets over the past thirty years. We also find that the correlation rises in periods when the conditional volatility of markets is large. There is some preliminary evidence that economic variables such as the dividend yield and interest rates contain information about future volatility and correlation that is not contained in past returns alone. However, further theoretical work is required to provide a satisfactory model. The effects are not of great magnitude but are often statistically significant.