Average Correlation And Stock Market Return-Myassignmenthelp.Com

Question: Discuss About The Average Correlation And Stock Market Return? Answer: Introducation A portfolio is a combination of different assets or assets classes in a group. An investor would generally have a portfolio of assets and the aim of the investor is to maximise returns with minimum risk (Pollet Wilson, 2007). This can be achieved by diversifying the portfolio. A diversified portfolio is the one in which the correlation between stocks in the portfolio is low (Bausys, 2013). Correlation is the relationship between stocks with respect to their price movements. The correlation between two stocks can be positive or negative and ranges in between -1 to +1. Negatively correlated stocks have low correlation and when the price of one stock increases, the price of the other stock decreases and vice versa. Whereas for positively correlated stock, when the price of one stock increases, the price of the other stock will also increase and vice versa. Beta of a stock measures its volatility to the market. Beta higher than 1 means the stock is more volatile than the market and if t he market increases, the price of the stock increases more than the market and vice versa. Correlation and beta are different in the sense that correlation measures the strength of the volatility of the stock and the volatility is measured by the beta (Apt, 2014) In the present case, there are two stocks News Media and HR Resources in a portfolio. Individually New Media has better expected returns and the standard deviation is also low. The coefficient variation is higher for New Media which means it has greater volatility of returns. Both the stocks have a negative correlation of -0.47 which means that when the price of stocks of New Media decrease, the price of HR Resources will increase by 47%. This makes the portfolio diversified as both stocks move in the opposite direction so when price of one stock is falling, the price of other stock will increase and the overall return on the portfolio will not be affected much, thus minimising the risk. The portfolio standard deviation is at 0.04 which is less than or almost equal to the individual stocks standard deviation. HR Resources has a beta of more than 2.66 which means that when the market return increase by 1%, the returns of HR Resources will increase by 2.6% thus offering higher volatili ty. News Media has a negative beta which means that the return of the stock will be opposite to the market returns. Beta of more than 1 means higher volatility which also means further strengthening of the correlation because when the market returns increase, the returns on stocks of HR Resources will increase by more than double as beta is 2.66, however the returns of New Media will fall. In case of falling market, News Media will give positive returns higher than the decrease in the market returns, however the returns of HR Resources will fall. Thus, the well diversified portfolio will offer higher returns than the market even though one stock is performing poorly. References Apt, A. (2014). The Alpha and Beta of Investing. Advisors Perpectives, Inc. Bausys, M. (2013, June 25). Correlation Analysis: The First Step Towards Portfolio Diversification. Retrieved September 19, 2017, from Seeking Alpha: https://seekingalpha.com/article/1519802-correlation-analysis-the-first-step-towards-portfolio-diversification Pollet, J., Wilson, M. (2007). Average Correlation and Stock Market Returns.