Factors affecting Optimal corridor width— Can someone explain the concept behind - higher the correlation, wider the optimal corridor ? Thanks!
i haven’t hit that section yet, but i’m guessing higher correlation, less diversification, higher risk, wider optimal corridor.
Let’s say you set up a policy target of 60/40 between two asset class (I didn’t say 60 equity 40 FI on purpose); and somehow those two asset moves in the same direction. Well, if those asset moves in the same direction (high correlation), after a up or down market movement, your portfolio will be still 60/40 (or close to that). Therefore, you don’t need to rebalance. Does this make sense?
Good explanation ws, but the interesting thing I find is that if the assets move together fairly closely why would you want a wide corridor if it isn’t “supposed” to trigger it. It seems as if you would want a narrow corridor because you’d expect it to not trigger it very often and if it does you’d see if some asset class isn’t exactly moving as you’d have thought. And on the flipside they say the larger volatility the more narrow corridor, I’d almost disagree and say with more volatility you would expect it to fluctuate on a short term basis so if you don’t want to have to rebalance every few weeks you’d set the corridor a little larger and only re-balance when its significant in relative terms. The process seems counterintuitive to me, but maybe I’m weird.
It is little counter-intuitive. Here is the bottom line: If you want to rebalance less====> wider corridor. If you want to rebalance more===> narrow corridor. Having those said, if asset corrleation is high, therefore your portfolio won’t be out of whack too much, therefore you can rebalance less frequently (wider corridor). If assets have high volatility, your portfolio will be more likely to be out of whack, therefore, you want to rebalance more frequently (narrow corridor). Does this help to clear up a little? Thanks