Why if volatility is high, the optimal corridor should be narrower? I thought it would be wider due to higher chances of breaching the corridor. And why if correlation among assets is high, the optimal corridor should be wider? Thanks
If the volatility is high you would have a greater chance to go wildly off balance, thus stricter monitoring would be necessary (i.e. narrower corridor). If the assets are highly correlated, they would not deviate from the strategic allocation % as easily. Thus, less stringent monitoring would be necessary (i.e wider corridor).
all boils down to probability and cost of rebalancing to maintain the asset target. if the volatility is high then you need a tighter leash on the asset weight to prevent drift… if the correlation with other assets is high then when it moves up so does the rest of the portfolio and hence more or less preserving the weights so you can afford to have a looser leash ( wider corridor)
state it this way, if the volatility is high, any small deviation in the beginning will have a higher possibility to move farther, thus causing imbalance to be more serious. so for higher volatility asset, must set a narrower corridor to detect this move earlier. correlation is high means that the portfolio has better capiility to rebalance by itsself, so do not need to act that eailer. if one asset moves earlier, other assets have higher possibility to move in same direction, achieving the similar balancing ratio soon. Charles
So if volatility is high, chances of moving outside the corridor are higher. Setting a narrower corridor would force more frequent rebalancing, hence more transaction costs (taxes, commission etc), underperformance. So why set is narrower?
if you do not set it narrower - you have much less chance of detection that you are going way off whack - and therefore not meeting the requirements of the IPS you are trying to fulfill. So it is a question of how much monitoring vs. how much rebalancing and the timeliness of the whole thing. additionally - if you find yourself going out of whack too soon, you can revisit the asset allocations, and restructure those in the context of the IPS during the next meeting with the investor.
mik82 Wrote: ------------------------------------------------------- > So if volatility is high, chances of moving > outside the corridor are higher. Setting a > narrower corridor would force more frequent > rebalancing, hence more transaction costs (taxes, > commission etc), underperformance. So why set is > narrower? Remember the strategic asset allocation? The investor wants exposure to a controlled systematic risk. What will happen to a foundation, that can take risk, suddenly discover that its target 70% exposure to equities is now 45%?
early warning system .
mik82 Wrote: ------------------------------------------------------- > So if volatility is high, chances of moving > outside the corridor are higher. Setting a > narrower corridor would force more frequent > rebalancing, hence more transaction costs (taxes, > commission etc), underperformance. So why set is > narrower? IMO, it assume that the benefit is higher than the cost. By the way, Can CCPI have a corridor width? When to rebalance with CPPI strategy?