Correlation Between DOW JONES and OAT

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Can any of the company-specific risk be diversified away by investing in both DOW JONES and OAT 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 DOW JONES and OAT into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between DOW JONES INDUSTRIAL and OAT Inc, you can compare the effects of market volatilities on DOW JONES and OAT 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 DOW JONES with a short position of OAT. Check out your portfolio center. Please also check ongoing floating volatility patterns of DOW JONES and OAT.

Diversification Opportunities for DOW JONES and OAT

0.6
  Correlation Coefficient

Poor diversification

The 3 months correlation between DOW JONES and OAT is 0.6. Overlapping area represents the amount of risk that can be diversified away by holding DOW JONES INDUSTRIAL and OAT Inc in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on OAT Inc and DOW JONES 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 DOW JONES INDUSTRIAL are associated (or correlated) with OAT. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of OAT Inc has no effect on the direction of DOW JONES i.e., DOW JONES and OAT go up and down completely randomly.
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Pair Corralation between DOW JONES and OAT

Given the investment horizon of 90 days DOW JONES is expected to generate 39.44 times less return on investment than OAT. But when comparing it to its historical volatility, DOW JONES INDUSTRIAL is 16.55 times less risky than OAT. It trades about 0.03 of its potential returns per unit of risk. OAT Inc is currently generating about 0.07 of returns per unit of risk over similar time horizon. If you would invest  3.31  in OAT Inc on September 6, 2022 and sell it today you would lose (1.06)  from holding OAT Inc or give up 32.02% of portfolio value over 90 days.
Time Period3 Months [change]
DirectionMoves Together 
StrengthSignificant
Accuracy99.8%
ValuesDaily Returns

DOW JONES INDUSTRIAL  vs.  OAT Inc

 Performance (%) 
       Timeline  

DOW JONES and OAT Volatility Contrast

   Predicted Return Density   
       Returns  

DOW JONES INDUSTRIAL

Pair trading matchups for DOW JONES

The effect of pair diversification on risk is to reduce it, but we should note this doesn't apply to all risk types. When we trade pairs against DOW JONES as a counterpart, there is always some inherent risk that will never be diversified away no matter what. This volatility limits the effect of tactical diversification using pair trading. DOW JONES's systematic risk is the inherent uncertainty of the entire market, and therefore cannot be mitigated even by pair-trading it against the equity that is not highly correlated to it. On the other hand, DOW JONES's unsystematic risk describes the types of risk that we can protect against, at least to some degree, by selecting a matching pair that is not perfectly correlated to DOW JONES INDUSTRIAL.

Pair Trading with DOW JONES and OAT

The main advantage of trading using opposite DOW JONES and OAT positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if DOW JONES position performs unexpectedly, OAT 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 OAT will offset losses from the drop in OAT's long position.
The effect of pair diversification on risk is to reduce it, but we should note this doesn't apply to all risk types. When we trade pairs against DOW JONES as a counterpart, there is always some inherent risk that will never be diversified away no matter what. This volatility limits the effect of tactical diversification using pair trading. DOW JONES's systematic risk is the inherent uncertainty of the entire market, and therefore cannot be mitigated even by pair-trading it against the equity that is not highly correlated to it. On the other hand, DOW JONES's unsystematic risk describes the types of risk that we can protect against, at least to some degree, by selecting a matching pair that is not perfectly correlated to DOW JONES INDUSTRIAL.
The idea behind DOW JONES INDUSTRIAL and OAT Inc 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.
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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 Transaction History module to view history of all your transactions and understand their impact on performance.

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