Correlation Between Small Capitalization and Large Cap
Can any of the company-specific risk be diversified away by investing in both Small Capitalization and Large Cap 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 Small Capitalization and Large Cap into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between Small Capitalization Portfolio and Large Cap Value, you can compare the effects of market volatilities on Small Capitalization and Large Cap 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 Small Capitalization with a short position of Large Cap. Check out your portfolio center. Please also check ongoing floating volatility patterns of Small Capitalization and Large Cap.
Diversification Opportunities for Small Capitalization and Large Cap
0.86 | Correlation Coefficient |
Very poor diversification
The 3 months correlation between Small and Large is 0.86. Overlapping area represents the amount of risk that can be diversified away by holding Small Capitalization Portfolio and Large Cap Value in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Large Cap Value and Small Capitalization 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 Small Capitalization Portfolio are associated (or correlated) with Large Cap. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Large Cap Value has no effect on the direction of Small Capitalization i.e., Small Capitalization and Large Cap go up and down completely randomly.
Pair Corralation between Small Capitalization and Large Cap
Assuming the 90 days horizon Small Capitalization Portfolio is expected to generate 1.59 times more return on investment than Large Cap. However, Small Capitalization is 1.59 times more volatile than Large Cap Value. It trades about 0.11 of its potential returns per unit of risk. Large Cap Value is currently generating about 0.12 per unit of risk. If you would invest 663.00 in Small Capitalization Portfolio on August 29, 2024 and sell it today you would earn a total of 62.00 from holding Small Capitalization Portfolio or generate 9.35% return on investment over 90 days.
| Time Period | 3 Months [change] |
| Direction | Moves Together |
| Strength | Strong |
| Accuracy | 100.0% |
| Values | Daily Returns |
Small Capitalization Portfolio vs. Large Cap Value
Performance |
| Timeline |
| Small Capitalization |
| Large Cap Value |
Small Capitalization and Large Cap Volatility Contrast
Predicted Return Density |
| Returns |
Pair Trading with Small Capitalization and Large Cap
The main advantage of trading using opposite Small Capitalization and Large Cap positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if Small Capitalization position performs unexpectedly, Large Cap 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 Large Cap will offset losses from the drop in Large Cap's long position.The idea behind Small Capitalization Portfolio and Large Cap Value 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 Commodity Channel module to use Commodity Channel Index to analyze current equity momentum.
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