The promise of modern portfolio theory was that a basket of uncorrelated assets would provide better risk-adjusted returns, over time, than a portfolio whose constituents move together. The problem that confronted many investors in 2008 and in the years since was that, in a crisis, even traditionally dissimilar assets had the potential to become highly correlated, making diversification efforts fruitless. Investors concerned that a portfolio of stocks might become increasingly correlated in a crisis have turned to equity index options to protect against that risk. In “Option-Implied Correlations and the Price of Correlation Risk,” Driessen, Maenhout, and Vilkov argue that correlation risk is a priced factor that can be measured from equity option prices.
