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Portfolio Risk and Correlation RSS

riskstudent

Posted: 06 May 2010 08:40 PM   [ Ignore ]
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Assume that I hold a $1billion portfolio of US. 30-year bonds.

Now I take a short position in $200 million of US 10-year bonds. These 10-year bonds have a correlation of 0.8 to the 30-year bonds.

What will happen to my portfolio risk, it will increase or decrease? Please explain.

Remember that the new position is a short position.

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David Harper, CFA, FRM, CIPM

Posted: 07 May 2010 01:06 PM   [ Ignore ]   [ # 1 ]
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In case it’s helpful, i’ll add a mathematical hint:

portfolio variance (A+B) =weight(A)^2*variance(A) + weight(B)^2*variance(B) + 2*weight(A)*weight(B)*correlation(A,B)*volatility(A)*volatility(B)
... and the short position enters as a negative weight; e.g., weight(B) = -$200/(1000 - 200) = -25%

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