Moondog
Term

Correlation

The degree to which two assets move together.

Correlation ranges from minus one to plus one. Combining assets that are imperfectly correlated is the mechanism behind diversification: it lowers portfolio risk without necessarily lowering expected return.

The cruel feature of correlation is that it tends to rise in a crisis, exactly when diversification is most needed. Assets that looked independent can fall together when fear takes over. Robust portfolios are built expecting correlations to spike under stress, not assuming calm-market relationships hold.

Related terms

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