Risk when Correlations Go to One

Risk when Correlations Go to One

A popular expression after the financial crisis of 2007-2009 was “correlations go to one”. What that means is that, in periods of great financial distress, many securities fall dramatically in price at the same time even when their returns were not highly correlated in normal market conditions. Some securities, such as short-term Treasuries actually rose in price. The expression “correlation go to one” is not meant to be literally applied to all assets. The expression is used to remind us that portfolios that appear protected by hedges or by diversification may not in fact be low risk during a liquidity event or other major crisis.

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