Contagion in correlation
Why do separate assets start moving together during a sell-off, and what does that tell a holder?
In plain words
Contagion in correlation is the tendency for assets that usually trade on their own to fall in step when a market sells off. Measured with a correlation coefficient, a value near one means the two assets' price moves are almost the same.
Why it matters
Diversification relies on assets not moving together. When correlation rises in a downturn, holding several assets offers less protection than the individual holdings suggest, because a single wave pulls all of them down at once.
In a real week: ETH, week of 12 March 2018
In the week of 12 March 2018, ETH fell 25.52% while the BTC-ETH hourly return correlation reached 0.89. ETH still lost 11.43 percentage points more than BTC, and the ETH-BTC ratio dropped 13.3%, so the two assets fell closely together while ETH fell harder.
A common mistake
Reading high correlation as the assets being identical. In that week the two moved together yet ETH lost far more, so relative performance still mattered.