Asset Allocation: Portfolio Diversification

The risk (as measured by volatility) of a portfolio can be dramatically different from the risks of the individual assets that comprise the portfolio. This is because, with a portfolio, you must account for both the risk of the individual assets and the degree of correlation or covariance between each asset in the portfolio. The effect of diversification on a portfolio is investigated and particularly how the individual assets in a portfolio are correlated. We then examine how a well-diversified portfolio is achieved and the role of the efficient frontier in helping us find the optimal portfolio.