Correlation in Crisis
Updated 2026-08-17
INTRODUCTION
English translation pending.
CORE DEFINITION
A risk principle stating that correlations are not stable: in normal markets distinct assets move independently, but under stress they converge toward one, because leverage unwinds, margin calls force selling, and liquidity disappears everywhere at once. The pattern was documented across the 2008 financial crisis and the March 2020 liquidity shock, when equities, credit, and commodities fell together. It implies that diversification must be judged on tail correlations rather than average ones, and that portfolios need genuinely defensive holdings and cash buffers, not merely a large number of positions.
SCAFFOLDING EFFECT
Reduce cognitive load
- Tail stress test: Re-estimate correlations under a crash scenario instead of using calm-period averages. - Hedge audit: Check whether each diversifier still holds up when margin calls hit. - Liquidity reserve: Size the cash buffer for forced selling rather than for normal redemptions.
Anchor fast decisions
In calm markets, heterogeneous holders trade on different information, so prices drift apart. Under stress the same constraint hits everyone at once: collateral values drop, margin calls arrive, and funds must raise cash by selling whatever is liquid. That synchronised selling pushes returns toward a common factor, so the diversification that came from independent positions disappears precisely in the states where losses matter most.
MINIMUM ACTION
In progress 0/1Practice this model in one real situation:
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Source support: Explicit
- github.comhttps://github.com/kcchien/model-thinkingverified
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