It says that greater volatility of the returns on the other assets in a portfolio suggests narrower optimal corridor widths because deviations from optimal weights can lead to even greater deviations when asset returns are highly volatile.
i don’t get what this means.
Can you guys pls help thanks
returns are volatile, will affect the total value/size (weight) of that particular asset in the portfolio, will need to rebalance more…our goal is to rebalance without much costs…hence narrow corridor to limit the transaction fees
the more an asset class moves away from “target” - the more you would have to spend to get it back to target. So to minimize the costs - if an asset class is more volatile (tendency for its returns to vary much more) - a narrower corridor is selected - so you do not have to buy or sell as much - and therefore costs are reduced for rebalancing.
Doesn’t it more have to do with, the greater volatility am asset has, the greater potential drift from your target and SAA, so a narrower corridor is required to prevent excess drift (mainly)?
Another consideration is the correlation of asset prices (not asset returns): the higher the correlation, the wider the corridors can be, even if prices (or returns) are quite volatile; the lower the correlation, the narrower the corridors should be, even if prices (or returns) aren’t particularly volatile.
To me it sounds oposite. The more volatile the asset the more chances that it will get outside the corridor. So if the corridor is too narrow --> it would require more frequent rebalancing. Doesnt it mean that a more volatile asset should have a wider corridor to prevent excessive rebalancing?