I found this question in another thread but most of that was related to factor of volatility, I’ll put my question here again: Should high correlations in portfolio assets lead to wider corridors or narrow? If they are highly correlated, if one asset weight moves, the other one moves in the same direction (assuming two-asset portfolio), so the overall weights remain more or less same hence narrower corridors can be set. This seems to be the logical explanation, and Sshweser QBank question ID# 40113 affirms this by stating “The high correlation between U.S. Government bonds and U.S. Corporate bonds implies that both assets classes should stay within acceptable limits even if we decide to set relatively small corridors.” and the right answer to the question is an agreement to the above statement. However, CFAI text says higher the correlation, wider should be the corridors. Why? They haven’t explained why it should be set wider. They have explained the impact on denominator of higher correlations, and the weights of assets staying relatively constant though. But that explanation favors narrower bands…
higher correlation means we could worry less about sticking to target weights (higher level of equity means higher level of debt ) hence we could allow wider corridor
you use narrow corridors if you are afraid of each asset class moving (quickly) far away from desired allocations schweser wording in that question is misleading, because they don´t say that you should use narrower or wider corridors, they just say that “they will not deviate a lot even if we use narrow corridors” you should use wider corridors if you are more focus on avoiding higher transaction costs (because of more frequent rebalancing) than on avoiding deviations from target weights hope it helps
Your first point makes quite sense hala. thanks guys for explaining!