hard · Frm Part 2 Risk & Investment Management
A fund with significant smoothing (AR(1) = 0.5) has a reported correlation of 0.3 with the S&P 500. A lag-adjusted beta regression reveals that the fund also has a correlation of 0.3 with the S&P 500 *lagged* by one month.
What is a more accurate estimate of the fund's economic correlation?
- 0.3, because correlations cannot be summed like betas.
- 0.15, the average of the two correlations.
- Higher than 0.3, as the true exposure is spread across current and prior market moves.
- 0.0, because the positive correlation with the lag implies the current correlation is an error.
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