In finance , correlation trading is a strategy in which the investor gets exposure to the average correlation of an index.

Volatility Dispersion Trading by Qian Deng :: SSRN

The key to correlation trading is being able to predict when future realized correlation amongst the stocks of a particular index will be greater or less than the "implied" correlation level derived from derivatives on the index and its single stocks. One observation related to correlation trading is the principle of diversification , which implies that the volatility of a portfolio of securities is less than or equal to the average volatility of all the securities in that portfolio based on Modern portfolio theory.

The lower the correlation among the individual securities, the lower the overall volatility of the entire portfolio.

This is due to the way in which variances behave when summing correlated random variables. In practice, exchange-traded funds ETF's are sometimes chosen instead of indices. From Wikipedia, the free encyclopedia.

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Dispersion Trading

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