Question

What is the standard deviation of the optimal risky portfolio?

Answer 1

Standard deviation of optimal risky portfolio-

For an optimal portfolio, investors always combined risky and risk-free

assets to mitigate the average risk. Risky assets portfolio will generate higher returns to the investors.

Expected return= E(RC)= WpE(Rp)+ (1-Wp)Rf

Where, Rp= risky return, Rf= risk free return

Variance of optimal risky portfolio= Var(Rc) = w²pVar(Rp)

And standard deviation=σ(Rc) = Wpσ(Rp)

Here Wp is the part of money invested in the risky portfolio.

It measures increase in expected returns per unit of standard deviation. As a result the institutional investors will estimate their percentage of return from risky assets and according to that they will invest for long run purpose.

The portfolio will become optimal only when the slope for capital allocation line (CAL) is highest. It means that the portfolio achieves highest return per every unit of standard deviation.