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The Dow's correlation with the market is well over 90% and it isn't equal-weighted.
by beefman 7y ago
The Dow's correlation with the market is well over 90% and it isn't equal-weighted.
- smabie 7y agoPrice weighted. Maybe even worse. Moreover, correlation isn't enough. What you would want to look at is the Beta exposure (covariance of the asset/portfolio and the market divided by the variance of the market) if you were deciding whether something was representative of the market.
- nuclearnice1 7y agoThanks for the definition of beta. I hear it thrown around, but never knew. Beta of Dow Jones is .98 to the S&P 500. [1] [1] https://www.zacks.com/stock/chart/INDU/fundamental/beta https://www.zacks.com/stock/chart/INDU/fundamental/beta
- beefman 7y agoAn asset's Beta is the product of its market correlation and volatility ratio. Highly volatile assets can have beta near 1 even when they have low market correlation. That's why CAPM statistics usually include R-squared along with Beta. More generally, in constructing optimized portfolios, correlations are important, not Betas. To your original point, 30 large firms are generally plenty to capture the market factor, regardless of weighting. For one thing, market-weighted indices are dominated by their top names (the top 30 names in the S&P 500 constitute over 40% of the index presently). More importantly, summing quickly suppresses uncorrelated variance, and there's a point after which adding additional names does very little. (I think there's a phase transition, actually – see Lello et al's recent report on polygenic risk scores, which use LASSO regression...[1]) [1] https://arxiv.org/abs/1709.06489 https://arxiv.org/abs/1709.06489