hi everyone and wish everybody first of all every success during the upcoming Saturday.
Just a short one: we know from the curriculum that if assets in the portfolio are more volatile this would imply narrower rebalancing corridor. However, I cant remember which practice question that was, It stated as a correct answer that “high risk assets” would imply wider corridors. If we assume that more risky assets are more volatile both statements are cotradictory, any thoughts?
I think you mean high correlation assets warrant a wider corridor since the chance will be smaller that assets will deviate from their target weights. In the absence of transactions costs, higher volatility warrants narrower corridor since chance of deviation from optimal SAA is more likely.
If you have risky assets you need a narrower corridor width.
A volatile asset is more likely to breach the corridor and since it is a risky security it can have a very negative impact on your overall portfolio. That’s why you need a narrower width, to monitor it very closely
Check the newly released AA practice questions from CFAI, here is the official answer from CFAI:
Theoretically, higher-risk assets would warrant a narrower corridor because high-risk assets are more likely to stray from the desired strategic asset allocation. However, narrow corridors will likely result in more frequent rebalancing and increased transaction costs so in practice corridors width is often specified to be proportionally greater the higher the asset class’s volatility. Thus, higher-risk assets should have a wider corridor to avoid frequent, costly rebalancing. Beade’s other suggestions are not correct. Less liquid asset classes should have a wider, not narrower, corridor width. Less liquid assets should have a wider corridor to avoid frequent rebalancing. For taxable investors, transactions trigger capital gains in jurisdictions that tax them. For such investors, higher tax rates on capital gains should be associated with wider (not narrower) corridor widths.