If market is efficient, it should mean revert to the target and corridor should be wider, right? However I have seen materials say mean reverting environment suggests narrower corridor and that market efficiency doesn’t affect corridor at all…I’m lost…
I haven’t seen anything in the curriculum regarding this, so I don’t think you should worry.
depending on your arguments, a higher market efficiency can warrant either a narrower or a wider corridor.
if market is efficient, prices move very quickly to adjust to any kind of new information, thus implying a higher volatility and so corridor should be narrower.
That makes sense, never thought about it that way. Thanks!
My take is that if markets are mean reverting, your corridor is going to be narrower to benefit from rebalancing. I.e. as assets start to become overweight (overvalued) you decrease your exposure and the subsequent correction has a lower impact on your portfolio. The opposite is true, as assets become underweight, rebalancing increases your exposure to the subsequent gain.
If you were to let your assets run freely, you might become overly exposed to a decline in a market, or underexposed to a gain in the market.