Hello, I have a question about strategic asset allocation. Is there a rule of thumb I.e. A percentage threshold that stipulates a correlation between two assets are low or not? One of the 2007 questions I was doing implied that 71pct and 80pct are low correlations between the 2 assets. I believe the question no. Was 4. Thanks in advance!
you if given 2 assets and if is a good diversifier could calc the new std deviation- just the way back from L1 formula w^2stddev^2 + w^2stddev^2 + 2w1w2stddev1stddev2(correlation)… and see if the new std dev is lower than the old one. i doubt the test would get much more math oriented than that. .7 or .8 on the surface to me seems like a fairly high correlation, but it’s of course all relative. i don’t have the test in front of me…
an asset adds value to existing portfolio if: Portfolio-Sharpe * correlation(New-asset with portfolio) < New-asset-Sharpe This is the relevant thumb-rule to decide if strategic allocation needs to accommodate new asset.