correlation between asset classes

CFA Level I
#1

In defining asset classes as part of the strategic asset allocation decision, pairwise correlations within asset classes should generally be: A. equal to correlations among asset classes. B. lower than correlations among asset classes. C. higher than correlations among asset classes

C is correct. As the reading states, “an asset class should contain homogeneous assets… paired correlations of securities would be high within an asset class, but should be lower versus securities in other asset classes.”

Is anyone able to re-word this to help my understanding?

My understanding is that within in asset class in your portfolio you want each stock to have strong correlation with that asset class but each individidual stock to have a low correlation with each other. Is that even relevant here? Slightly confused…

#2

An asset class is supposed to contain assets that behave quite similarly; this suggests that they should have high correlations of returns with each other.

Distinct asset classes are supposed to behave differently; this suggests that correlations of returns between asset classes should be be low.

#3

Thanks.

#4

You’re welcome.