Abstract
The 2007-2008 financial crisis will be remembered for many exceptional facts. Among them, the spectacular increase in stock market’s volatility and correlation. This has been interpreted as a sort of structural break in stock market’s dynamics and a proof of the fallacy of one of the central tenets of financial advisory services: the importance of portfolio diversification. I will show, on the contrary, that this phenomenon is not at all surprising, given the increase in market volatility, and it derives from a very simple dynamic CAPM model. I calibrate the model over the last 20 years and show that it fits very well the observed dynamic of stock markets’ volatility and correlation. Finally, I use the model to investigate if the 2007-8 environment should have been detrimental to bottom-up managers and favourable for top-down manager, as far as “alpha” creation is concerned.