the market portfolio is 100% diversified… only systematic risk… does this mean a beta of one? i am just trying to figure out something from an old question i cant find… lets say 2 assets. asset A correlation .90 asset B caoorlation .20 if we want to be well diversified would we want portfolio A b/c it is closer to the market portfolio w/ beta of 1?
merket portfolio is indeed the most diversification possible and it’s beta is 1 therefore out of the two portfolios the most diversified is the one that has the correlation 0.9 because correlation to the market would translate into a beta of 0.9, right?
florinpop, i dont think that is necessarily true because beta values can exceed -1(rare) and +1, although the correlation coefficient is bounded by these numbers. so i dont think it translates into a 1 to 1 relation…
nikko0355 Wrote: ------------------------------------------------------- > the market portfolio is 100% diversified… only > systematic risk… > does this mean a beta of one? Yes. > > i am just trying to figure out something from an > old question i cant find… > lets say 2 assets. > asset A correlation .90 > asset B caoorlation .20 > > if we want to be well diversified would we want > portfolio A b/c it is closer to the market > portfolio w/ beta of 1? The question doesn’t state what the correlation is with (is it the market portfolio…some other asset?). If you were looking to add one of these assets to your current portfolio, without return numbers, you would pick asset B because it has a lower correlation. There are few diversification benefits to adding asset A because of it high correlation with the current potfolio. I am not sure you can figure this out with the information given. Was there more to the question?
Mr_Clean Wrote: ------------------------------------------------------- > florinpop, i dont think that is necessarily true > because beta values can exceed -1(rare) and +1, > although the correlation coefficient is bounded by > these numbers. so i dont think it translates into > a 1 to 1 relation… True. You could have a stock with a beta of 2.0 that has a correlation of say +1 to your current portfolio. That would mean that the assets would move in lockstep, but the stock would have bigger moves to the upside and downside. This would mean that there were no diversification benefits to adding the stock to the portfolio. Take a look at the formula for figuring out Standard Deviation for a two asset portfolio…with a correlation of +1 the third term in the formula has no benefit. It would then just become a weight average of your individual component standard deviations. But if you have less than +1 SD then the third term start to reduce the overall portfolio’s SD (no longer a weighted average of the two).
lets say 2 assets. asset A correlation .90 asset B caoorlation .20 Mwvt9 the question states that for example, A has a correlation with the market of 0.9 does not that mean that the Beta is 0.9?
No. As Mr. Clean pointed out, how could you explain a stock with a beta of 1.6? What would the correlation be? It can’t be greater than +1. I will put some yearly return numbers to the example I was trying to use above (M is the market and A is asset A): Yr 1 M 1% A 2% Yr 2 M 5% A 10% Yr 3 M -15% A -30% In this case the correlation of the assets would be +1, but the beta would be 2. The market and Asset A move in lockstep, but asset A just has bigger swings.
thanks I think studying too much lately has made me stupid
florinpop, here is an easy way to remember. beta = correlation*[stdev(stock)/stdev(market)] the first component of beta is correlation, the second the ratio of stdev of a stock and the market. for a fixed correlation of 0.5, beta can be equal to any positive number (within a reasonable range) depending on how volatile it is.
makes sense maratikus. basically correlation gives the direction and intensity and the std gives the amount?