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As we increase the number of stocks in a portfolio, the standard deviation of returns of...

As we increase the number of stocks in a portfolio, the standard deviation of returns of the portfolio ________ if the stocks that comprise the portfolio are ________.

decreases; perfectly correlated

increases; not perfectly positively correlated

increases; perfectly correlated

decreases; not perfectly positively correlated

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Answer #1

As we increase the number of stocks in a portfolio, the standard deviation of returns of the portfolio DECREASES if the stocks that comprise the portfolio are NOT PERFECTLY POSITIVELY CORRELATED.

If the stocks added in portfolio are perfectly correlated, means, they move in the same direction as the other stocks are moving, then the deviation will increase. So, on should add stock which are not perfectly positively correlated , ie of different business models or different industries, which will create a natural hedge.

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