Economics 26/12/2009: Irish banks - twinned by crisis

A picture worth a thousand words:
Let me quickly explain - these are close price correlations (1 month moving) for AIB and Bank of Ireland. I divided the entire time horizon into 4 zones:

• Zone 1: through December 2004 - the tail end of the pre-credit bubble conditions, when Irish economy still had some residual Celtic Tiger growth in it. And, aptly, the banks were still financing growth in real economic activities. Thus, we clearly have periods where correlations fall below 0.3 levels, signaling some differences between the two banks. And they occasionally were reaching below zero, signaling substantial differences between the banks.
• Zone 2: January 2005-July 2007 - the credit bubble. During this period, the two banks worked hard on erasing any significant differences. One went to the UK, another followed. One landed in 100% mortgages, another followed. One started to throw money after cowboy developers. The other followed. And so on. If in the previous period, min-min correlations envelope (the extent of diversification offered by the shares pair) ranged from -33% to -37% and to -47% (implying occasional flight to hedge opportunities of substantial degree and rising though out the period), in the Zone 2 period, min-min envelope ranged from -28% to -6.4%, shrinking the flight to hedge opportunities. In other words, the two shares were much poorer diversification instruments against each other.
• Zone 3: August 2007 - January 2009 - the credit bubble bursting period. Here, the two shares converged to telling virtually an identical story. It was, indeed, true that by the end of this period, BofI and AIB became virtually indistinguishable. One's own risk was matched by the other risk. And the min-min envelope shrunk from 37% to 41%, getting dangerously close to that 50% mark.
• Zone 4: Since February 2009, the min-min envelope has contracted to 79.3% signaling that in effect the two shares have no substantial differentiation between them. In other words, from the point of risk hedging or risk-return consideration (e.g. under mean-variance criterion-based models) there is no reason to hold both stocks in a diversified portfolio. The surprising, indeed amazing, stability of these correlations since February 2009 suggests that the markets have reached the new equilibrium - or the New Long Term, where the markets no longer are caring for separating BofI from AIB.

One more thing is worth adding. You'd think that a look at pairwise correlations between two largest banks in this country would be warranted for our technically apt and smart stockbrokers... You'd be wrong - as far as I know, none seemed to have been bothered to send their clients a simple chart on correlations between the two banks.