Question

Question:

The data set includes 5 years of monthly returns for three indexes: (1) The S&P 500, a portfolio of US equities (2) The Russell 2000, a portfolio of US equities (3) The Nikkei 225, a portfolio of Japanese equities. Use the CORREL function in Excel to calculate the correlation between the returns of each of the three pairs of index returns (S&P vs Russell, S&P vs Nikkei, Russell vs. Nikkei). The spreadsheet includes an example of how to use the CORREL function. Based on your results, is there an advantage to diversifying your existing portfolio with international stocks rather than domestic stocks? Why or why not?

CORREL Results from Data Set:

S&P500 and Russell 2000 correlation- 0.9074

S&P 500 and Nikkei 225 correlation- 0.7483

Russell 2000 and Nikkei 225 correlation- 0.6752

Answer 1

In general Yes, because as if the index of domestic decreases, it will affect the other domestic stock but by diversifying the stocks with international stocks the returns get diversifies.

Both domestic and international stocks are giving a positive correlation, so diversifying should be done as per below result.

CORREL Results from Data Set:

S&P500 and Russell 2000 correlation- 0.9074

S&P 500 and Nikkei 225 correlation- 0.7483

Russell 2000 and Nikkei 225 correlation- 0.6752