Time-Series and Cross-Sectional Excess Comovement in Stock Indexes

This paper is an empirical investigation of the excess comovement of industry indexes in the U.S. stock market over the period January 1973 to December 2001. We define excess comovement as the correlation between two assets beyond what could be explained by fundamental factors. In our analysis, the fundamental factors are sector groupings and the three Fama-French factors. We then estimate excess comovement as the mean absolute correlation of residuals of univariate (OLS) or joint (FGLS) regressions of these fundamentals on industry returns. We show that excess unconditional comovement is surprisingly high (a lower bound of 0.134 and an upper bound of 0.357) and represents between 31% and 83% of the average raw absolute correlation. Excess comovement is also consistently significant across industries and over our entire sample interval. Furthermore, we find that the degree of excess comovement is symmetric, i.e., not significantly different in rising or falling markets. We explain approximately 21% of this excess correlation by its positive relation to market volatility, and reveal a negative relation of its lower bound to the level of the short-term interest rate.