The Times Change : Multivariate Subordination, Empirical Facts

The management of correlation risk is of the utmost importance in several areas of investment banking: multi-asset derivatives pricing and hedging, optimal asset allocation, risk management, statistical arbitrage and many others. However, the modelling of correlation as a physical phenomenon - as opposed to that of the volatility, say - is still in its infancy. In this note, we present a mechanism for the arising of a stochastic covariance matrix in financial markets, and therefore, an explanation of the returns heavy tailed joint distribution. This mechanism relies on sampling returns according to an appropriate event time. Using CAC 40 high frequency data, we compare the predictions of our model to real world statistics and find a very good agreement between both