As diversification increases, the total variance of a portfolio approaches
A)0.
B)1.
C)the variance of the market portfolio.
D)infinity.

Question

Quizplus · Accepted Answer

The total variance of a portfolio approaches the variance of the market portfolio as diversification increases. This is because the market portfolio represents the most diversified portfolio possible and therefore has the least amount of unsystematic risk. As a portfolio becomes more diversified and includes more stocks, it becomes increasingly similar to the market portfolio and its variance approaches that of the market portfolio.

As Diversification Increases, the Total Variance of a Portfolio Approaches