(a) Suppose you create an equally weighted portfolio (holding weights 1/2) of 2 independent stocks (Cov...

(a) Suppose you create an equally weighted portfolio (holding weights 1/2) of 2 independent stocks (Cov (i,j)=0). What is the portfolio variance?

(b) Suppose you create an equally weighted portfolio (holding weights 1/3) of 3 independent stocks (Cov (i,j)=0 for all i and j). What is the portfolio variance?

(c) Suppose you create an equally weighted portfolio (holding weights 1/4) of 4 independent stocks (Cov (i,j)=0 for all i and j). What is the portfolio variance?

(d) Generalize your results.

Solutions

Expert Solution

d. covariance is a statistical measure of the directional relationship between two asset returns. hence from above, we can generalize that when covariance between two stock is 0 the variance of the portfolio is equal to the weighted average of variance which is proved in the above calculation.

please find the above image for the solution to point 1,2,3.

the solution involves assumptions and the alternative method for calculating the same also exist.

jeff jeffy answered 1 year ago

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