Reductions in the variance of risk in a portfolio of stocks can only be accomplished when the the correlation among the stocks i

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Oksana_A [137]

3 years ago

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Reductions in the variance of risk in a portfolio of stocks can only be accomplished when the the correlation among the stocks i

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Business

2 answers:

Agata [3.3K] · Answer 1 · 2022-05-12T20:46:49+03:00

A variance of risk in a portfolio of stocks can be reduced when the correlation among the stocks or two stocks is negative. In reality, perfect negative correlation is difficult to attain (if not impossible). A company must split its assets or attempt to find several assets that respond to different forces in the economy. When one asset is losing, there’s a good chance that the other one is gaining.

Vikki [24] · Answer 2 · 2022-05-12T22:42:14+03:00

The reductions in the variance of risk can only be completed when the moves are negatively correlated.

Further Explanation:

Risk in the portfolio:

The stocks involve both systematic risk and unsystematic risk, but only unsystematic risk is diversified. The diversification refers to the procedure of combining different kinds of securities in the portfolio to reduce the risk.

The correlation is used to determine the relationship between two securities in the portfolio. The link between the correlation and diversification is as follows:

Negative correlation: If the two stocks are negatively correlated means that both the stock will move in the opposite direction.

Positive Correlation: If the two stocks are positively correlated means that both the stock will move in the same direction.

Uncorrelated: If the two stocks are uncorrelated means that each stock move independently of the other stock.

Therefore, if the stocks are negatively correlated, the risk of the portfolio can be reduced because both the stocks move in the opposite direction.

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Answer details:

Grade: High School

Subject: Security Analysis and Portfolio Management

Chapter: Risk Analysis

Keywords: Reductions in the variance of risk in a portfolio of stocks, can only be accomplished when the correlation among the stocks, risk analysis, negative correlation, positive correlation.