The effectiveness of portfolio diversification can be measured by the coefficient of determination,that is the correlation between excess returns on the market and those on the fund.

Question

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The coefficient of determination, also known as R-squared, measures the amount of variability in one variable (in this case, excess returns on the fund) that can be explained by another variable (excess returns on the market). Therefore, a high coefficient of determination indicates that the portfolio is well-diversified and that the excess returns on the fund are strongly correlated with the excess returns on the market.

The Effectiveness of Portfolio Diversification Can Be Measured by the Coefficient