The guideline answers say that high volatility for commodities is a reason to narrow the corridors.
In my notes, high volatility = wider corridors to, avoid constant capital gains taxes and transaction costs. Nothing in the question implied that there were no transaction costs/taxes.
Could someone please explain
I think ive came cross similar question and as far as i know, the high volatility leads to narrow corridor due to its deviation from designated weighting. I am not 100% convinced with it but that was what i was told
High volatility = low corridor widths to prevent major deviations in the folio which would throw the portfolio off its desired risk profile.
This is mentioned in the errata regarding one of the questions. You can check it out.
From the errata:
Practice Problem 2 (page 315 of print) should be rewritten as follows: “For clients concerned about rebalancing-related transactions cost, which of Beade’s suggested changes in the corridor width of the rebalancing policy is correct? The change with respect to:” The solution (page 318 of print) should be rewritten as follows: “A is correct. Theoretically, higher-risk assets would warrant a narrow 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 corridor 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 costs. Her 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 costs. 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.”
Gotcha. So in a vacuum, you want narrow corridors for high volatility, strictly from an asset allocation/risk management perspective. In reality, there is a trade-off with transaction costs, but it is still intrinsically valuable for the corridors to be narrow
Based off the errata, I would say that it’s the opposite
“so in practice corridor width is often specified to be proportionally greater the higher the asset class’s volatility.”
high volatility = narrow corridor
high volatility = wide corridor for illiquid assets
Tatics got it. In the book they use the example of a domestic bond.