Correlation Between Small Capitalization and Mid Capitalization

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

By analyzing existing cross correlation between Small Capitalization Portfolio and Mid Capitalization Portfolio, you can compare the effects of market volatilities on Small Capitalization and Mid Capitalization 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 Capitalization with a short position of Mid Capitalization. Check out your portfolio center. Please also check ongoing floating volatility patterns of Small Capitalization and Mid Capitalization.

Diversification Opportunities for Small Capitalization and Mid Capitalization

0.96

Correlation Coefficient

Small Capitalization  Mid Capitalization

Almost no diversification

The 3 months correlation between Small and Mid is 0.96. Overlapping area represents the amount of risk that can be diversified away by holding Small Capitalization Portfolio and Mid Capitalization Portfolio in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Mid Capitalization and Small Capitalization 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 Capitalization Portfolio are associated (or correlated) with Mid Capitalization. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Mid Capitalization has no effect on the direction of Small Capitalization i.e., Small Capitalization and Mid Capitalization go up and down completely randomly.

Pair Corralation between Small Capitalization and Mid Capitalization

Assuming the 90 days horizon Small Capitalization Portfolio is expected to under-perform the Mid Capitalization. In addition to that, Small Capitalization is 1.09 times more volatile than Mid Capitalization Portfolio. It trades about -0.13 of its total potential returns per unit of risk. Mid Capitalization Portfolio is currently generating about -0.07 per unit of volatility. If you would invest  1,376  in Mid Capitalization Portfolio on December 27, 2024 and sell it today you would lose (69.00) from holding Mid Capitalization Portfolio or give up 5.01% of portfolio value over 90 days.

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

Small Capitalization Portfolio  vs.  Mid Capitalization Portfolio

Small Capitalization

Risk-Adjusted Performance

Very Weak

Over the last 90 days Small Capitalization Portfolio 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.

Mid Capitalization

Risk-Adjusted Performance

Very Weak

Over the last 90 days Mid Capitalization Portfolio has generated negative risk-adjusted returns adding no value to fund investors. In spite of fairly strong basic indicators, Mid Capitalization is not utilizing all of its potentials. The current stock price disturbance, may contribute to short-term losses for the investors.

Pair Trading with Small Capitalization and Mid Capitalization

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

The idea behind Small Capitalization Portfolio and Mid Capitalization Portfolio 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 Price Exposure Probability module to analyze equity upside and downside potential for a given time horizon across multiple markets.