While the portfolio return is a weighted average of realized security returns, portfolio risk is not necessarily a weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and actually reduce the riskiness of a portfolio.

Question

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The diversification effect of combining securities in a portfolio allows investors to reduce the overall riskiness of the portfolio even if individual securities have high standard deviations. Therefore, portfolio risk is not necessarily a simple weighted average of the standard deviations of the securities in the portfolio.

While the Portfolio Return Is a Weighted Average of Realized