Corridor Width

CFA Level III
#1

Can anybody explain to me why low correlation of assets translates into narrower corridors ?

#2

Say you have 2 assets and they are -1 correlated. So we start off with 50/50 split. If A is up 10%, then B is down 10% so it goes from 50/50 to say 55/45. If the had a correlation fo +1 then the weightings would have stayed 50/50. So you need a narrower corridor b/c they will need to be rebalanced more often to keep them inline with allocations.

#3

If they have high correlation, then variation in the returns will be similar. Essentially, keeping the same %s as the original settings. So, you can get by with wider corridors, since the allocations won’t get out of line. If the correlation is low, then variation in each asset allocation will be different, distributing the original scheme. Thus you would need narrower corridors to keep the allocations within the target ranges.

#4

Thanks. I got that. Same q about the volatility.

#5

If you have large volatility then you want to sent your corridors lower (v5 p365 CFAI text has a great table that summarizes this) Positive Relationship w Corridor Width (Higher Corridor Width for Higher Value) • Transaction Costs • Risk Tolerance • Correlation with Portfolio Inverse Relationship with Corridor Width (Lower Corridor Width for Higher Value) • Asset Class Volatility - if you don’t rebalance this, further divergence is likely.(4 steps forward + 2 steps back… pretty soon you are way out of alignment) • Portfolio Volatility - same as above

#6

Data_Monkey Wrote: ------------------------------------------------------- > If you have large volatility then you want to sent > your corridors lower (v5 p365 CFAI text has a > great table that summarizes this) > > Positive Relationship w Corridor Width (Higher > Corridor Width for Higher Value) > • Transaction Costs > • Risk Tolerance > • Correlation with Portfolio Also liquidity > > Inverse Relationship with Corridor Width (Lower > Corridor Width for Higher Value) > • Asset Class Volatility - if you don’t rebalance > this, further divergence is likely.(4 steps > forward + 2 steps back… pretty soon you are way > out of alignment) > • Portfolio Volatility - same as above