Which of the following statement(s) is(are) true regarding the variance of a portfolio of two risky securities? I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance.
II) There is a linear relationship between the securities' coefficient of correlation and the portfolio variance.
III) The degree to which the portfolio variance is reduced depends on the degree of correlation between securities.

Question

Quizplus · Accepted Answer

III is correct because the portfolio variance reduction indeed depends on the correlation between the securities; a lower correlation generally leads to greater diversification benefits and thus a greater reduction in variance. I is incorrect because a higher coefficient of correlation between securities actually leads to less reduction in portfolio variance, not greater. II is incorrect because the relationship between the securities' coefficient of correlation and the portfolio variance is not linear; it's more complex and depends on the weights of the securities in the portfolio as well as their individual variances.

Which of the Following Statement(s) Is(are) True Regarding the Variance