If an asset is highly volatile, should the rebalancing corridor be wider or narrower? From the way I see it, a wider corridor would require less rebalancing but more deviations from the strategic asset allocation. A narrower corridor would stick more closer to the strategic asset allocation but result in more rebalancing related costs. The CFA Question Bank/Curriculum has given two different views on this. Question 22 of the online question bank says:
“Radell indicates that a wider rebalancing range for the global fixed-income fund is appropriate. …The lower the volatility of an asset class relative to the rest of the portfolio, the wider the optimal rebalancing corridor.” -> which means that the higher the volatility of asset class, narrower the optimal rebalancing corridor.
But the curriculum on Pg 318 (Vol 3) says that “…Higher-risk assets should have a wider corridor to avoid frequent, costly rebalancing…”
depends on the approach, is managing costs more important or is risk in this instance?
is this the whole question, in the absence of more information then a smaller corridor should be the appropriate answer I would think - in order to manage the risk of the volatile asset class.
however if there’s an emphasis on cost control, a wider tolerance is acceptable as frequent rebalancing would be required under a narrower corridor, causing an increase in transaction costs.
If the asset class is volatile, you have to put a narrow band on the rebalance otherwise the asset class could get out of proportion very fast (and obviously that would increase transaction costs).
If the asset class has low volatility, you can put a wider band because it will likely not move very much, so you can give it more room to breath.
Thanks for this. In the 2020 Qbank I ran across this same question and I noticed this in the beginning of the vignette when speaking about the company’s objectives:
“minimize the administrative and investment costs associated with managing the fund”
To your point, I think the answer on whether its narrower or wider in the case of volatility, its dependent upon the objective.
minimize the administrative and investment costs associated with managing the fund”