Decoupling - Explained
What is Decoupling?
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What is Decoupling?
Decoupling refers to a situation in which security prices or returns on asset behave differently from the expected pattern. When different assets classes that exhibit certain similar behaviours behave contrary to their normal correlations or patterns, decoupling has occurred. For instance, if two classes of assets increase and decline together but at a time they begin to exhibit diverging behaviours contrary to what they are known for, decoupling has occurred. In this situation, one can notice one class of the asset rises in price while the declines. Different classes of assets that usually move (fall or rise) together but begin to behave in different patterns have been decoupled.
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How Does Decoupling Work?
Correlation is a measure used in the investment market to determine the mutual relationship between two or more assets. When assets fall and decline together, they are correlated. When correlated assets or investments begin to exhibit different behaviors contrary to their pattern of correlation, decoupling has occurred. In this situation, one class of asset increases while another decreases as against their regular previous pattern. Usually, in investments, investors and portfolio managers choose diversified portfolio which entails that investments or assets do not have correlating behaviours. In this vein, if investors allocate their investment in diversified portfolios, if the value of one investment falls, the other does not have to follow the trend.
Decoupling of Markets
Decoupling can also occur to markets and economies. A good example of decoupling of markets is the 2008 financial crisis. Usually, markets are coupled in terms of growth and increase attributable to them. Due to the coupled nature of markets, the financial crisis in 2008 led to a decoupled market or economy. The Financial crisis was later diluted across all markets in the world causing a global recession despite that it started in the United States. Also, in certain economies, economic growth of emerging business is dependent on that of the large businesses in a way that if the large businesses enjoy profit, the emerging business follows the same thread. However, a situation in which an emerging business has no dependence on a larger business for profitability or loss, decoupling has occurred.