PM is giving me fits. I can see & understand why the math works but I guess i’m just having a hard time conceptualizing things.
First: The idea of reducing risk but achieving the the same level of return seems too good to be true.
Second: It seems like the goal is to have a portfolio whose assets are negatively correlated (-1), to maximize diversification benefits, thus reducing risk. Is this true ? If so, it doesn’t make sense to me. If one asset gains 10% while the other loses 10% then you have no return/gain. I realize this is better than having losses but at the same time you never gain anything either…
Perhaps this example is wrong bc the book gives an eample with -1 correlation and the result is a portfolio whose expected return = 13.3% but with a 0% stdev. Clearly, this goes against my 10% gain - 10% loss offsetting example, but I JUST DON’T UNDERSTAND HOW YOU CAN GAIN WHEN THE ASSETS ARE PERFECTLY NEG CORRELATED…IS THIS NOT ARBITRAGE AT ITS FINEST??
I clearly need some insight. Please help, anyone. Thank you