Question

Why do assets of the same type who positive covariances of returns with each other? Would you expect positive covariances of returns between different types of assets such as returns on Treasury bills, General Electric common stock, and commercial real estate? Why or why not?

Answer 1

Similar assets like stocks in the same industry for example steel industry, exhibits the positive covariance because of the factors affecting the companies are same like steel prices, raw materials and others factors. Their profit and risk factors will move together according to the industry dynamics. stock prices will exhibit positive relationship, hence positive covariance

The different assets will not have positive covariances because the returns from the different assets will not be as correlated. Each asset will exhibit different risk and return profiles. For ex, General electric common stock exhibits high risk and return whereas, treasury will exhibit risk free return. So, they will have the negative correlation.