online business resources

It is often supposed that investors do not like risk; they are convinced that the good surprises fail to compensate for the bad ones. They would consequently prefer the same returns while incurring a lower degree of risk.
The more the correlation coefficient is negative, the more one endeavors to diminish average risk by applying negatively correlated instruments. If the investor is indeed ‘‘risk-averse’’, he will make sure that the latter are as negatively correlated as is feasible. Then again, the mere fact that the financial instruments are not strictly correlated enables diversification to play an appreciable role.
The correlation of two financial instruments takes on a value between – 1 and + 1. The lower the correlation between a financial asset and a portfolio, the more the volatility of the latter is diminished once the former is added to the portfolio. If one adds securities that are negatively correlated with the portfolio, then the volatility of the latter will be very much diminished. If the new financial assets have no correlation with the portfolio (its coefficient correlation is 0), adding such a security will nonetheless reduce the volatility of the portfolio. Even with a positive correlation coefficient, provided that it is less than 1, adding a supplementary asset diminishes the risks incurred by a portfolio. If we limit ourselves to stock portfolios, studies show that maximal risk diversification is attained with at least 20 shares of firms operating in heterogeneous industrial sectors. Needless to say, if you specialize in stocks for skis, ice skates, fur jackets and 17 shares in industries related to cold weather, your portfolio will be poorly diversified notwithstanding your 20 shares! In contrast, you must try to introduce shares that are not positively correlated. It is also necessary for the probability distributions and the degrees of correlation between them to remain stable for a sizable length of time. The more we study long periods of time, the less reliable are the available statistics. How long is long enough? During calm spells studies by institutional investors analyze and survey the degrees of correlation that may exist between the different categories of financial assets: the stocks of large-scale groups, medium-sized companies, government bonds, corporate bonds, junk bonds, real estate, hedge funds and so on. One must remember that securities that are riskier than a portfolio when taken individually may, in spite of everything and provided that they are not correlated with the portfolio, reduce the overall risks of the latter.
Such factors help to explain the interest in international diversification; it can be expected that economic crises will not take place simultaneously in every country. This approach is supported by the observation that in each country, stocks evolve as a function of the ups and downs of the local economy. Money flows likewise introduce negative correlations between stock market performances and exchange rates. Lowering risk through international diversification largely compensates for the risk linked to exchange rates. Yet with the ongoing internationalization of the activities of quoted companies, the impact of purely local or national factors tends to diminish. A French economist, Bruno Solnik, has shown that for an internationally diversified firm, asset returns are determined to a significant extent by non-domestic (rather than domestic) factors. Moreover, the sensitivity of individual company returns to non-domestic factors is integrally linked to the scope of their international activities, as represented by the relative importance of foreign sales in relation to total sales.