How should the historical data affect decision making

Each stock has volatility which can be broken down

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Unformatted text preview: reasing the size of a portfolio can reduce the expected volatility as measured by standard deviation without necessarily compromising expected return – this is why diversification makes mathematical csense How can this theory break down? If correlations are nto stable over time If correlations go to 1 in a panic: All correlations went to 1 in 2008, because no one was able to predict the future so everyone tried to sell simultaneously Trigger mechanism was fall of Lehman brothers People were not thinking of selling for diversification but instead for cash If risk is something other than volatility We are building assumption that volatility is risk, and not probability it goes to 0 etc. What kind of risk can diversification reduce? It does not reduce systematic risk, you can’t diversify it away worldwide. (can do it for US systematic risk if you have international portfolio) We can diversify idiosyncratic/company risk: start off with one stock you have a lot of systematic risk, but if there are a lot, you can reduce risk a lot. Stock volatility: If an investor is forced to bear risk, they must be compensated for it. If you can get...
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This document was uploaded on 03/27/2014 for the course FINC 150 at Georgetown.

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