Correlation Between DOW and EAFE Small-Cap

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

Diversification Opportunities for DOW and EAFE Small-Cap

0.96
  Correlation Coefficient

Almost no diversification

The 3 months correlation between DOW and EAFE Small-Cap is 0.96. Overlapping area represents the amount of risk that can be diversified away by holding DOW and EAFE Small-Cap Ishares in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on EAFE Small-Cap Ishares and DOW 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 are associated (or correlated) with EAFE Small-Cap. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of EAFE Small-Cap Ishares has no effect on the direction of DOW i.e., DOW and EAFE Small-Cap go up and down completely randomly.
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Pair Corralation between DOW and EAFE Small-Cap

Given the investment horizon of 90 days DOW is expected to generate 0.93 times more return on investment than EAFE Small-Cap. However, DOW is 1.08 times less risky than EAFE Small-Cap. It trades about 0.04 of its potential returns per unit of risk. EAFE Small-Cap Ishares is currently generating about 0.02 per unit of risk. If you would invest  2,570,609  in DOW on March 31, 2022 and sell it today you would earn a total of  532,322  from holding DOW or generate 20.71% return on investment over 90 days.
Time Period3 Months [change]
DirectionMoves Together 
StrengthVery Strong
Accuracy100.0%
ValuesDaily Returns

DOW  vs.  EAFE Small-Cap Ishares

 Performance (%) 
      Timeline 

DOW and EAFE Small-Cap Volatility Contrast

 Predicted Return Density 
      Returns 

DOW

Pair trading matchups for DOW

Kroger vs. DOW
TOURMALINE OIL vs. DOW
Pacific Gas vs. DOW
Gran Tierra vs. DOW
Star Bulk vs. DOW
Genie Energy vs. DOW
San Juan vs. DOW
Stealthgas vs. DOW
Radian vs. DOW
American Manganese vs. DOW
Valhi vs. DOW
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 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'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'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.

Pair Trading with DOW and EAFE Small-Cap

The main advantage of trading using opposite DOW and EAFE Small-Cap positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if DOW position performs unexpectedly, EAFE Small-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 EAFE Small-Cap will offset losses from the drop in EAFE Small-Cap's long position.

DOW

Pair trading matchups for DOW

Walgreens Boots vs. DOW
Gran Tierra vs. DOW
Pacific Gas vs. DOW
Radian vs. DOW
San Juan vs. DOW
TOURMALINE OIL vs. DOW
Mesabi Trust vs. DOW
U S vs. DOW
Star Bulk vs. DOW
Geely Automobile vs. DOW
Daqo New vs. DOW
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 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'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'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.
The idea behind DOW and EAFE Small-Cap Ishares 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 Premium Stories module to follow Macroaxis premium stories from verified contributors across different equity types, categories and coverage scope.

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