Risk
Correlation measures how closely two assets move together; low correlation improves diversification.
Correlation measures how strongly two assets move in step. It runs from –1 (perfectly opposite) through 0 (independent) to +1 (perfectly aligned).
For diversification, assets with low or negative correlation are ideal. Take an example: equities and long-dated government bonds have historically often shown low or negative correlation. When equities fell, bonds frequently rose.
A caution: correlations are not stable. In a crisis they often rise, precisely when diversification is needed most. This phenomenon is known as a "correlation breakdown".
Related terms
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