What causes the asymmetric correlation in stock returns

The literature indicates that the correlations between the returns of individual stocks and the aggregate market are significantly larger during negative market-wide movements than during positive market-wide movements. In this study we examine the underlying cause(s) of this asymmetric correlation in stock returns. We find that firms’ cash flow news and other indicators of firm operating performance have asymmetric correlations that mimic that of stock returns. We also find that other potential causes of asymmetric correlation, such as trading activities, arbitrage constraints, conditional conservatism, and earnings management, exhibit insignificant (or marginally significant at best) asymmetric correlations. We further find that the asymmetric correlation observed in stock returns is significantly related to those in firm operating performance. Finally, there is some evidence that a firm’s ability to innovate explains the increases in individual firms’ operating performance during bull markets while the firm’s distress risk explains the aggregate decreases in firm performance during bear markets.