In order to benefit from diversification, the returns on assets in a portfolio must:
A) be perfectly positively correlated.
B) be perfectly negatively correlated.
C) positively correlated but not perfectly.
D) have the same idiosyncratic risks.

Question

Quizplus · Accepted Answer

Diversification benefits are achieved when assets have positively correlated but not perfectly correlated returns. This allows for some assets to perform well when others do not, reducing overall portfolio risk. Perfect positive correlation means that all assets move together, while perfect negative correlation means that they move in opposite directions, both of which limit the benefits of diversification. Idiosyncratic risk, or risk specific to one asset, is not relevant to diversification benefits as it can be diversified away through a diversified portfolio.

In Order to Benefit from Diversification, the Returns on Assets