Portfolio Correlation Inspector

The degree to which equities in a portfolio move together is the basis of portfolio optimization and solid portfolio management. To originate a well-diversified portfolio, you would want stocks that do not closely follow each other or the market. But to what degree? The Macroaxis Correlation Inspector helps to map out the relationship between the returns on prices of different equities across different time horizons.



Correlation Inspector runs correlations between the returns of each asset your portfolio. It constructs a conventional correlation table with color-coded cells, identifying the highest and lowest values, as well as values that fall within 1, 2, and 3 standard deviations from 0

Diversification

An investor can reduce portfolio risk simply by holding instruments which are not perfectly correlated. In other words, investors can reduce their exposure to individual asset risk by holding a diversified portfolio of assets. Diversification will allow for the same portfolio return with reduced risk. If all the assets of a portfolio have a correlation of 1, i.e., perfect correlation, the portfolio volatility (standard deviation) will be equal to the weighted sum of the individual asset volatilities. Hence the portfolio variance will be equal to the square of the total weighted sum of the individual asset volatilities. If all the assets have a correlation of 0, i.e., perfectly uncorrelated, the portfolio variance is the sum of the individual asset weights squared times the individual asset variance (and volatility is the square root of this sum). If correlation is less than zero, i.e., the assets are inversely correlated, the portfolio variance and hence volatility will be less than if the correlation is 0.

Types of diversification

There are two main types of diversification.
1. Horizontal diversification is when a portfolio is diversified between same-type of financial instruments. It can be a broad diversification (like investing in stocks from NYSE) or more narrowed (investing in several stocks of the same branch or sector).
2. Vertical diversification is investment between different types of securities. Again, it can be a very broad diversification, like diversifying between bonds and stocks, or a more narrowed diversification, such as diversifying between stocks of different branches.
Please note that changing model inputs can significantly alter your desired optimal asset allocation. Make sure you carefully select your inputs before running the model !


Please note, the New York Stock Exchange (NYSE) and American Stock Exchange (AMEX) have recently merged. Although Macroaxis has implemented solutions to handle this transition gracefully, you may still find some securities that may not be fully transferred from one exchange to another.