“The higher the volatility of a given asset class, the narrower the optimal corridor.” This seems counterintuitive. Wouldn’t a narrower corridor trigger excessive re-balancing and associated transaction costs in this case? Hence, shouldn’t the optimal corridor be wider? Would appreciate any insight on this. Thanks.
Vol and Corridor width are inversely related. In an environment of high volatility, you would prefer a narrower corridor.
Okay, but wouldn’t this end up with a re-balancing every time the asset moved outside the narrow corridor? In a high volatility environment this moving outside the corridor would happen a lot which would leave you with a massive re-balancing bill.
you want narrow widths so you can detect violations sooner…if you had larger corridors, and volatile assets, the assets could move dramatically befor eyou had a chance to rebalance. if you weren’t able to rebalance in time it would throw off your risk and return profiles a lot.
if left without rebalancing the target mix will very quickly go out of synch. there was a whole lot of discussion on this. you may want to search for the post.
Here is the one ‘krishna’ is referring to most likely… http://www.analystforum.com/phorums/read.php?13,734654,734781#msg-734781
gaoyao Wrote: ------------------------------------------------------- > “The higher the volatility of a given asset class, > the narrower the optimal corridor.” > > This seems counterintuitive. Wouldn’t a narrower > corridor trigger excessive re-balancing and > associated transaction costs in this case? Hence, > shouldn’t the optimal corridor be wider? > > Would appreciate any insight on this. > > Thanks. CFA Institute says: Higher volatility => Optimal Corridor Width Higher The above is really false. If you want to look at an analysis for “optimality” you can try Constantinides “Capital Market Equilibrium with Transaction Costs,” Journal of Political Economy,. 94, 842–862, 1986. Constantinides analytically confirms the common intuition that for more volatility you want to have wider corridors. Of course for the exam you should do what will help you pass. J