Beruflich Dokumente
Kultur Dokumente
7-2
Firm-specific risk
Diversifiable or non-systemic
7-3
1-4
1-5
7-6
7-7
2
D
2
D
2
E
2
E
= Variance of Security D
2
D
2
E
= Variance of Security E
7-8
wD wDCovrD , rD
2
p
wE wE CovrE , rE
2wD wE CovrD , rE
7-9
Covariance
CovrD , rE DE D E
, = Correlation coefficient of returns
= Standard deviation of returns
for Security D
= Standard deviation of returns
for Security E
INVESTMENTS | BODIE, KANE, MARCUS 7-10
1-11
A portfolio of 3 Assets
You have three assets with weights
w 1, w 2, w 3
The portfolio return is simply the linear
combination of the returns with same
coefficients:
w1
w2
w3
w1
Cov(1,1)
Cov(1,2)
Cov(1,3)
w2
Cov(2,1)
Cov(2,2)
Cov(2,3)
w3
Cov(3,1)
Cov(3,2)
Cov(3,3)
w1
w2
w3
1, 2
1,3
1, 2
2,3
1,3
2,3
w1
w2
w3
Cova, b Covb, a a ,b
2
1
2
2
2
3
w1
w1
w2
w3
w
2
1
w1w2
w1w3
w2
2
1
1, 2
1,3
w3
w1w2 1, 2
2
2
2
2
w2 w3 2,3
w1w3 1,3
w2 w3 2,3
w
2
3
2
3
w w w
2
p
2
1
2
1
2
2
2
2
2
3
2
3
a ,b b ,a a ,b a b b ,a b a
INVESTMENTS | BODIE, KANE, MARCUS 1-16
w1
w2
w3
w1
w2
w1w2 1, 2 1 2
w3
2
1
2
1
w
2
2
w3 w3 2,3 2 3
2
2
w
2
3
2
3
w w w
2
p
2
1
2
1
2
2
2
2
2
3
2
3
2 w1w2 1, 2 1 2
2 w1w3 1,3 1 3
2 w2 w3 2,3 2 3
INVESTMENTS | BODIE, KANE, MARCUS 1-18
> -1.0
w w
2
p
2
D
2
D
2
E
2
E
2 wD wE DE D E
INVESTMENTS | BODIE, KANE, MARCUS 7-20
Correlation Coefficients
When = 1, there is no diversification
P wE E wD D
When = 1, a perfect hedge is when:
w w 2wD wE D E 0
2
p
2
D
2
D
2
E
2
E
wD
D E
and wE
D E
1 wD
If correlation < +1
the portfolio standard
deviation may be
smaller than that of
either of the individual
component assets.
If correlation = -1
the standard deviation
of the minimum
variance portfolio is
zero.INVESTMENTS |
BODIE, KANE, MARCUS
7-24
Portfolio
opportunity
set for given
correlation
Correlation Effects
The amount of possible risk reduction
through diversification depends on the
correlation.
The risk reduction potential increases as the
correlation approaches -1.
If r = +1.0, no risk reduction is possible.
If r = 0, P may be less than the standard
deviation of either component asset.
If r = -1.0, a riskless hedge is possible.
SP
E rP rf
P2 wi w j Covri , rj
n
i 1 j 1
1
wi
n
1 2
2
P 2 i
i 1 n
11
Cov ri , rj
i 1 j 1 n n
n
j i
n
n
1
Cov
Cov ri , rj
nn 1 i 1 j 1
j i
n n 1 terms
1
1 2
11
i
Cov ri , rj
n
i 1 n
i 1 j 1 n n
j i
2
2
P
as:
n n 1 terms
1 2 n 1
Cov
n
n
2
P
1 2 n 1
2
n
n
2
P
2
P
INVESTMENTS | BODIE, KANE, MARCUS 7-41
Risk Sharing
As risky assets are added to the portfolio, a
portion of the pool is sold to maintain a risky
portfolio of fixed size.
Risk sharing combined with risk pooling is the
key to the insurance industry.
True diversification means spreading a
portfolio of fixed size across many assets, not
merely adding more risky bets to an evergrowing risky portfolio.