We may not be able to fully remove risk by diversification if:
A) a completely risk-free asset does not exist.
B) the asset returns in our portfolio are positively correlated.
C) buying stock on margin is not allowed by financial regulators.
D) none of the above

Question

Quizplus · Accepted Answer

If the asset returns in our portfolio are positively correlated, then diversification will not be able to fully remove risk. This is because if the returns of the assets in our portfolio move in the same direction at the same time, then we will still experience significant losses even if we are diversified across multiple assets. Conversely, if the returns of the assets in our portfolio are negatively correlated, then diversification can effectively reduce risk. A completely risk-free asset not existing and regulations surrounding buying stock on margin are not relevant to the effectiveness of diversification.

We May Not Be Able to Fully Remove Risk by Diversification