Correlation vs. Trends in Portfolio Management: A Common Misinterpretation
5 Pages Posted: 19 Apr 2011
Date Written: April 12, 2011
Two common beliefs in finance are that (i) a high positive correlation signals assets moving in the same direction while a high negative correlation signals assets moving in opposite directions; and (ii) the mantra for diversification is to hold assets that are not highly correlated. We explain why both beliefs are not only factually incorrect, but can actually result in large losses in what are perceived to be well diversified portfolios.
Keywords: correlation, trends, diversification
JEL Classification: G10, G11
Suggested Citation: Suggested Citation