the standard deviation of a two-asset portfolio is less than the weighted average of the individual security standard deviations if the correlation of the two assets is

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10-11-2022
Physics

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the standard deviation of a two-asset portfolio is less than the weighted average of the individual security standard deviations if the correlation of the two assets is

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contexto1212 contexto1212 · Answer 1 · 2022-11-20T03:06:33-05:00

Firm-specific risk factors are eliminated by holding assets in a portfolio since these risk variables frequently cancel one another out. As a result, the standard deviation of a portfolio is typically lower than the standard deviation of the weighted average. The main advantage of diversification is this.

Systematic and ad hoc risk factors are both reflected by the standard deviation. A portion of the unsystematic risk is reduced when individual stocks are integrated into a portfolio, resulting in a portfolio standard deviation that is lower than the average of the standard deviations of the individual stocks. The SD of the portfolio will decrease if stocks that are not absolutely positively correlated with one another are included. The benefits of diversity are higher and the portfolio risk is lower when there are reduced correlations between the returns of the assets in the portfolio.

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