Question

The portfolio with the highest volatility has the worst correlation coefficient for diversification (in other words, the highest vol portfolio also has the most positive correlation coefficient). True? or False?

Is the lowest risk portfolio also the portfolio with the most diversification? In other words is the lowest risk portfolio also the most zero to negative correlation coefficient pair. True ? or False?

Answer 1

1. True

The portfolio with the highest volatility has the worst correlation coefficient for diversification (in other words, the highest volatility portfolio also has the most positive correlation coefficient.

Correlation coefficient is measure of how two stock are related to each other in respect of their price movement. IF two stocks are perfectly positively correlated i.e +1 then both stocks move in same direction with equal momentum which means if one stock is making loss then second stock is also making loss. thus, A portfolio has highest volatility if stocks are perfectly correlated because these stocks does not give diversification benefits.

2. True

The lowest risk portfolio also the portfolio with the most diversification? In other words is the lowest risk portfolio also the most zero to negative correlation coefficient pair.

It is opposite situation of above case, if portfolio has stocks pair with negative correlation coefficient then it has most diversification benefits and it force portfolio risk to lowest level.