A portfolio manager adds a new stock that has the same standard deviation of returns as the existing portfolio but has a correlation coefficient with the existing portfolio that is less than +1. Adding this stock will have what effect on the standard deviation of the revised portfolio’s returns? The standard deviation will: A) decrease only if the correlation is negative. B) increase. C) decrease. from Kaplan Schweser. In this scenario, as the correlation is positive, wouldn’t the the addition of a positively correlated stock increase the variance? if initial variance is say x and new stock is B new variance = x + 2*std(A) * std(B) * Cov A*B … B will have a additive equation with other stocks in the portfolio. What am I missing? Thanks
If the correlation of returns were +1.0, the standard deviation of returns of the portfolio would not change.
If the correlation of returns is less than +1.0, the standard deviation of returns of the portfolio will decrease.
Put some numbers into Excel and see what happens when you change only the correlation of returns.
Okay thanks
My pleasure.