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What is Asset Correlation? | Definition and Examples



What is Asset Correlation? | Definition and Examples

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When you first start investing, it can be difficult enough to understand what your investments are and how they work — let alone how they interact with one another. But it’s helpful to understand the relationship between different investments and how they act in relation to other assets.

Asset correlation is especially important to understand when you’re working to build a diversified portfolio. Keep reading to learn more about how asset correlation works, how it’s measured, and why it’s essential in building your investment portfolio.

What is Asset Correlation?

Asset correlation is a measure of how different investments move in relation to one another. Two assets that move in the same direction simultaneously are positively correlated, while those that move in opposite directions are negatively correlated. Some asset pairs have no correlation or relationship at all, which means they don’t tend to move with or against each other.

How to Measure Asset Correlation

Asset correlation is measured on a scale of -1.0 to +1.0. Not only does the scale measure whether two assets are correlated, but it also measures how closely related their movements are. The further to one side of the scale an asset falls, the stronger the positive or negative correlation. 

For example, two assets with a correlation of +1.0 are perfectly correlated, meaning they always move in the same direction at roughly the same percentage. And if two assets are -1.0, it means they’re perfectly negatively correlated. They’ll always move in opposite directions at the same amount. 

Finally, two assets with a correlation of 0 have no relationship whatsoever. The movement of one of the assets doesn’t necessarily mean the other will move or predict what direction it will move if it does.

A mathematical equation is used to calculate the correlation between two or more assets. The most common formula uses the covariance and standard deviation of each asset. However, a more straightforward way to measure it is by using an asset correlation calculator online. These calculators automatically calculate correlation using two stocks’ ticker symbols.

Asset Correlation Examples

To give you a greater understanding of asset correlation, let’s discuss a few examples of asset pairs that have positive correlations, negative correlations, and no correlation at all.

Positive Correlation

As we mentioned, a positive correlation between two assets means that they move in the same direction at the same time. And the more closely correlated they are, the more similar their movements are.

For example, if a stock gains 5% and is perfectly correlated to another stock, that other stock would also gain 5%.

Assets within the same industry are likely to have a high positive correlation since they’re affected by similar market factors. For example, two auto manufacturers in the United States would likely have a high positive correlation.

Negative Correlation

When assets negatively correlate, they tend to move in opposite directions. More strongly negatively correlated assets will be further apart from each other. For example, if two assets have a perfect negative correlation, when one gains 5% in the market, the other will lose 5%.

In our example of positive asset correlation, we looked at two companies’ stock prices in the same industry. To find examples of negative correlation, it makes more sense to look at two entirely different assets: Stocks and bonds.

When stock prices increase, investors tend to move away from bonds and look to the stock market. But when the stock market is down, investors tend to turn to bonds. Because of their negative correlation, investment experts recommend having both stocks and bonds in your portfolio. This allows you to hedge your risk no matter which way the market moves.

Zero Correlation

When two assets have zero correlation, it means they have no relationship with one another whatsoever. In these cases, it’s impossible to predict the movements of one asset based on the movement of the other.

In reality, it’s difficult to find assets with zero correlation. The effects of the overall market tend to affect other markets. However, certain assets may be less likely to be correlated with the overall market. Those assets can include real estate, commodities, art, and more.

Cash is another asset that rarely correlates with others. This is why many experts recommend keeping a portion of your portfolio in cash at all times in addition to investments that may have a correlation with one another.

Asset Correlation and Modern Portfolio Theory

Modern portfolio theory is a common investment strategy that seeks the perfect balance between portfolio risk and return. This theory is based on the premise that the market is generally efficient and that it doesn’t make sense for investors to forecast future investment returns or pick individual stocks. Instead, modern portfolio theory stresses the importance of diversification to minimize portfolio risk.

Asset correlation and modern portfolio theory are closely related. In fact, modern portfolio theory relies entirely on the premise that different investments have different relationships with one another.

When you follow modern portfolio theory, you include some assets that are positively correlated, some that are negatively correlated, and some that have no correlation at all. This way, no matter what happens with the market you’ll have some investments in your portfolio that perform well (along with the ones that perform poorly_.

Modern portfolio theory and asset correlation are useful tools for creating a well-diversified portfolio that can survive any market, but it’s not a perfect science. When we talk about perfectly positively- and negatively-correlated assets, we might assume that those assets will always have the same relationship. But that’s simply not the case. 

Today’s market especially is unpredictable, so the correlation between different assets can change. That’s not to say you shouldn’t keep asset correlation in mind when building your portfolio. Just remember that the correlation between two assets isn’t fixed.

Is Asset Correlation Important?

Understanding how asset correlation works is an important step when you build your investment portfolio, especially when it comes to market fluctuations and downturns

Again, an important example of asset correlation is the relationship between stocks and bonds. Most investment experts recommend including both asset classes in your portfolio. In fact, there are formulas for determining what percentage of your portfolio should be allocated to bonds. Some experts recommend a 90/10 stock to bond ratio. Others recommend subtracting your age from 120 and allocating that percentage of your portfolio to stocks.

As an investor, you’ll understand just how important asset correlation is when you experience your first market correction. It’s easy to panic when you see your stock market investments lose value. But because of what is often a negative correlation, you may notice that your bond investments are actually doing well.

It’s also important to note that correlation doesn’t always equal causation. Certain assets may tend to move in the same direction. But that doesn’t mean that the movement of one of the assets causes the movement of the other. It’s more likely that similar factors caused both assets to move. On the other hand, when two assets are negatively correlated, the positive movement of one doesn’t necessarily cause the negative movement of the other (though it could).

The Downside of Asset Correlation

The downside of relying on asset correlation when building your investment portfolio is that, as we mentioned, the relationship between two assets can change. Assets that once had a negative correlation can eventually come to have a positive correlation, and vice versa.

Understand that there are no guarantees. And you’re even more likely to see changes in the correlation between two assets in volatile and unpredictable markets.

It’s also difficult to predict how new assets will play a role in asset correlation. For example, cryptocurrency has become popular even during a time when the stock market is doing well. However, its performance has been volatile. And the jury is still out regarding whether it’s correlated to other assets and in what ways.

Bottom Line

Asset correlation describes the relationship between two investments. It’s an important concept to understand when you’re building a portfolio as it can help you choose your investments in a way that strikes the right balance of risk vs. reward.

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Sushiswap developers propose to divert 100% of fees generated to Sushi’s multisig



Sushiswap developers propose to divert 100% of fees generated to Sushi’s multisig

  • Sushiswap developers have submitted a new governance proposal to the community.

  • The proposal seeks to divert 100% of fees generated on the platform to Sushi’s multisig.

  • The funds would be used for Sushi’s multisig for a year or until new tokenomics are implemented.

Sushiswap developers want to divert trading fees

Developers of the decentralised finance (DeFi) protocol, Sushiswap, have submitted a new proposal to the community. According to the proposal, 100% of the fees generated on the platform would be diverted to Sushi’s multisig for one year or until new tokenomics are implemented.

This latest cryptocurrency news comes as Sushiswap is currently facing a significant deficit in its treasury. The deficit threatens the protocol’s long-term operational viability. 

In his proposal, the Head Chef, Jared Gray, said;

“After reviewing expenditures, it’s clear that a significant deficit in the Treasury threatens Sushi’s operational viability, requiring an immediate remedy. In my original proposal, Sushi operated with an annual runway of 9M USD. However, after my detailed review, we reduced that requirement to 5M USD. We made the reduction possible by renegotiating infrastructure contracts, scaling back underperforming or superfluous dependencies, and instituting a budget freeze on non-critical personnel and infrastructure.”

Despite reducing the project’s annual runway requirement from $9 million to $5 million, the treasury still provides for only about 18 months of runway.

The developers are now proposing to set up Kanpai, a fee-diversion protocol. The proposal, if accepted, will lead to 100% of fees diverted to the Treasury multisig for one year or until the project’s new token distribution and reward schemes become active. 

Sushiswap’s fee-diversion solution is temporary

The developers pointed out that the proposal is a temporary solution to a long-term problem. The proposal was put in place because new tokenomics will take time to implement

The Head Chef said;

“Kanpai is a temporary solution to a long-term problem, and a new tokenomics proposal is on the horizon, which will help address the long-term value proposition of Sushi for stakeholders. Sushi must implement a holistic token model that allows the rebuilding of the Treasury and delivers value for all stakeholders while reducing the fiscal liability carried solely by the protocol.”

In addition to Kanpai, the Sushi team said it increased its funding by securing several multi-million dollar partner deals. 

However, the developers added that relying on business development deals is only part of a successful business model to secure Sushi’s future. In October, asset management firm GoldenTree invested $5.2 million in Sushiswap.

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Europe’s McGuinness pushes for global rules after FTX collapse



Europe's McGuinness pushes for global rules after FTX collapse

Mairead McGuinness, financial services commissioner for the European Union spoke to CNBC in Brussels.

Bloomberg | Bloomberg | Getty Images

BRUSSELS — Some market players are purposely avoiding regulation in the crypto space, the EU’s top regulator told CNBC as she called for a global approach to protect retail investors.

The European Union agreed in June on the Markets in Crypto-Assets (MiCA) regulation. This is meant to reduce risks for consumers buying crypto assets. In essence, the rules mean providers would become liable if they lose investors’ crypto-assets, but the regulation is only due to start 12 months from now.

“It will not come into effect for a year, but I think it’s already having an effect,” Mairead McGuinness, European commissioner for financial services, told CNBC Tuesday.

She said that firms in the crypto industry that want to be part of the regulated system — and therefore have the seal of approval from a regulatory authority — are “already acting in a way that our legislation is pointing.”

However, she added that some crypto players are choosing to, and are fundamentally against, stricter rules.

“Some of those who were involved in crypto, from the very outset, were doing it because they didn’t want to be part of the regulated, managed system. They want it to be separate from and in parallel to it. That’s a very dangerous path,” she said.

Recent crises in the crypto world have clearly exposed the risks for consumers. The recent collapse of FTX, an exchange once valued at more than $30 billion, and the crash of supposed “stablecoin” terraUSD both highlighted the risks associated with these assets.

U.S. interest

The European Union has been stepping up rules in this space and has pushed for a global approach. In meetings last month, McGuinness discussed crypto regulation with her U.S. counterparts.

“What I found in the U.S. is huge interest in what we were doing here, and the markets and crypto assets legislation. And I believe there will be developments there,” she said.

In the wake of the downfall of FTX, some U.S. policymakers urged the Treasury to do more to tackle the risks for investors. The U.S. Treasury was not immediately available for comment when contacted by CNBC.

In the U.K., officials are reportedly working on a new plan to regulate crypto as well.

“We have seen events, let me put it like that, in this crypto space. Which maybe is a wake-up call for those who thought that investments would only increase in value,” McGuinness said.

She added that crypto is like climate change, in that it needed a global approach.

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New crypto wallet designed by iPod creator Tony Fadell



New crypto wallet designed by iPod creator Tony Fadell

The creator of the iPod, Tony Fadell, designed a new hardware wallet for people to store their cryptocurrency.

The product, created by French crypto asset security firm Ledger, launched at the company’s annual Ledger Op3n event Tuesday. Its launch comes at a time when trust in centralized crypto platforms is fading as a result of the collapse of Sam Bankman-Fried’s FTX.

It’s called Ledger Stax and resembles a small smartphone or credit card reader. Measuring 85 millimeters long and 54 millimeters wide, it’s roughly the same size as a credit card. It is also about 45 grams, weighing less than an iPhone. Users can deposit or exchange a range of tokens, including bitcoin, ether, cardano, solana and nonfungible tokens, or NFTs.

The Ledger Stax sports a black-and-white E-ink display, similar to that of Amazon’s Kindle e-readers. It also includes magnets, so that multiple devices can be stacked on top of each other, like a pile of books or cash — hence the name Stax. Users can connect it to their laptop through a USB cable or their phone via Bluetooth.

“Many Ledger owners have multiple devices, some store their NFTs, some store different crypto, some have multiple because they have different clients that they store for,” Fadell told CNBC in an interview.

The display also has a spine that curves around the edge, “so you can see what’s on each one, just like an old CD or cassette tape or book,” he said.

The iPod for crypto?

Initially, Fadell turned down working with the Ledger team on Stax. “This was not something I wanted to do,” he said. “When they first approached me I’m like, ‘I don’t want to do it. No thank you.’ I was interested in crypto, I had crypto at the time but I’ve basically got a lot of other things to do.”

The Ledger Stax is the latest hardware crypto wallet from French startup Ledger. It’s roughly the same size as a credit card and sports an E-ink display.

What is DeFi, and could it upend finance as we know it?

Ian Rogers, Ledger’s chief experience officer and a former executive at Apple and LVMH, said he’s confident about the mass market potential.

“There’s no question about the need for security and there’s no question that we lead increasingly online lives,” he told CNBC. “Instagram, Nike, Starbucks, Amazon — many companies are finding real life use cases for digital assets. And so I think that we will grow with that.”

Not your keys, not your crypto

After the recent collapse of FTX into insolvency, crypto holders have sought alternative means of storing their digital assets. One is via cold storage, where a user’s private key — the code they need to access their account — is kept on a device that’s not connected to the internet.

Since these wallets are offline, they’re less susceptible to hacks or failures. Ledger says that, to date, none of its devices have been hacked.

Ledger has seen a boost in sales as a result of fears around the contagion from the FTX collapse. Last week, BlockFi, a crypto lender, entered bankruptcy after revealing Alameda Research, Bankman-Fried’s trading firm, defaulted on $680 million worth of loans from the company.

November “will be our all-time high biggest month ever,” Pascal Gauthier, Ledger’s CEO, told CNBC. “All the news that you’ve seen since the beginning of the year, from Celsius all the way to FTX, has really pushed a lot of users towards self custody.”

Ledger has sold more than 5 million devices to date.

However, a sharp downturn in digital asset prices could spell trouble for the company with retail investors becoming more wary. Only 21% of Americans feel comfortable investing in cryptocurrency, according to Bankrate’s September survey. That’s down from 35% in 2021.

The Ledger Stax will compete with a slew of consumer gadgets this holiday shopping season, including Apple’s new iPhone 14, at a time when budgets are being constrained by rising inflation.

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