Correlation Between Small Cap and Large Company

Can any of the company-specific risk be diversified away by investing in both Small Cap and Large Company 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 Small Cap and Large Company into the same portfolio, which is an essential part of the fundamental portfolio management process.

By analyzing existing cross correlation between Small Cap Equity and Large Pany Value, you can compare the effects of market volatilities on Small Cap and Large Company 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 Small Cap with a short position of Large Company. Check out your portfolio center. Please also check ongoing floating volatility patterns of Small Cap and Large Company.

Diversification Opportunities for Small Cap and Large Company

0.89

Correlation Coefficient

Small Cap  Large Company

Very poor diversification

The 3 months correlation between Small and Large is 0.89. Overlapping area represents the amount of risk that can be diversified away by holding Small Cap Equity and Large Pany Value in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Large Pany Value and Small Cap 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 Small Cap Equity are associated (or correlated) with Large Company. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Large Pany Value has no effect on the direction of Small Cap i.e., Small Cap and Large Company go up and down completely randomly.

Pair Corralation between Small Cap and Large Company

Assuming the 90 days horizon Small Cap Equity is expected to under-perform the Large Company. In addition to that, Small Cap is 1.7 times more volatile than Large Pany Value. It trades about -0.32 of its total potential returns per unit of risk. Large Pany Value is currently generating about -0.12 per unit of volatility. If you would invest  2,180  in Large Pany Value on December 2, 2024 and sell it today you would lose (30.00) from holding Large Pany Value or give up 1.38% of portfolio value over 90 days.

Time Period	3 Months [change]
Direction	Moves Together
Strength	Strong
Accuracy	100.0%
Values	Daily Returns

Small Cap Equity  vs.  Large Pany Value

Small Cap Equity

Risk-Adjusted Performance

Very Weak

Over the last 90 days Small Cap Equity has generated negative risk-adjusted returns adding no value to fund investors. In spite of weak performance in the last few months, the Fund's basic indicators remain fairly strong which may send shares a bit higher in April 2025. The current disturbance may also be a sign of long term up-swing for the fund investors.

Large Pany Value

Risk-Adjusted Performance

Very Weak

Over the last 90 days Large Pany Value has generated negative risk-adjusted returns adding no value to fund investors. In spite of latest weak performance, the Fund's basic indicators remain strong and the current disturbance on Wall Street may also be a sign of long term gains for the fund investors.

Pair Trading with Small Cap and Large Company

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

The idea behind Small Cap Equity and Large Pany Value 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.

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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 the Efficient Frontier module to plot and analyze your portfolio and positions against risk-return landscape of the market..