Can any of the company-specific risk be diversified away by investing in both New Hope and SP Merval at the same time? Although using a correlation coefficient on its own may not help to predict future stock returns, this module helps to understand the diversifiable risk of combining New Hope and SP Merval into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between New Hope and SP Merval, you can compare the effects of market volatilities on New Hope and SP Merval and check how they will diversify away market risk if combined in the same portfolio for a given time horizon. You can also utilize pair trading strategies of matching a long position in New Hope with a short position of SP Merval. Check out your portfolio center. Please also check ongoing floating volatility patterns of New Hope and SP Merval.
Diversification Opportunities for New Hope and SP Merval
The 3 months correlation between New and MERV is -0.44. Overlapping area represents the amount of risk that can be diversified away by holding New Hope and SP Merval in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on SP Merval and New Hope is a relative statistical measure of the degree to which these equity instruments tend to move together. The correlation coefficient measures the extent to which returns on New Hope are associated (or correlated) with SP Merval. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of SP Merval has no effect on the direction of New Hope i.e., New Hope and SP Merval go up and down completely randomly.
Assuming the 90 days trading horizon New Hope is expected to under-perform the SP Merval. But the stock apears to be less risky and, when comparing its historical volatility, New Hope is 3.15 times less risky than SP Merval. The stock trades about -0.14 of its potential returns per unit of risk. The SP Merval is currently generating about 0.19 of returns per unit of risk over similar time horizon. If you would invest 51,407,400 in SP Merval on September 9, 2023 and sell it today you would earn a total of 38,042,800 from holding SP Merval or generate 74.0% return on investment over 90 days.
The main advantage of trading using opposite New Hope and SP Merval positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if New Hope position performs unexpectedly, SP Merval can make up some of the losses. Pair trading also minimizes risk from directional movements in the market. For example, if an entire industry or sector drops because of unexpected headlines, the short position in SP Merval will offset losses from the drop in SP Merval's long position.
The idea behind New Hope and SP Merval pairs trading is to make the combined position market-neutral, meaning the overall market's direction will not affect its win or loss (or potential downside or upside). This can be achieved by designing a pairs trade with two highly correlated stocks or equities that operate in a similar space or sector, making it possible to obtain profits through simple and relatively low-risk investment.
Check out your portfolio center.Note that this page's information should be used as a complementary analysis to find the right mix of equity instruments to add to your existing portfolios or create a brand new portfolio. You can also try the Risk-Return Analysis module to view associations between returns expected from investment and the risk you assume.
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