Diversification (finance) - Diversification With An Equally-weighted Portfolio

Diversification With An Equally-weighted Portfolio

The expected return on a portfolio is a weighted average of the expected returns on each individual asset:

where is the proportion of the investor's total invested wealth in asset .

The variance of the portfolio return is given by:

Inserting in the expression for :

Rearranging:

where is the variance on asset and is the covariance between assets and . In an equally-weighted portfolio, .

The portfolio variance then becomes:

Where is the average of the convariances for . Simplifying we obtain

As the number of assets grows we get the asymptotic formula:

Thus, in an equally-weighted portfolio, the portfolio variance tends to the average of covariances between securities as the number of securities becomes arbitrarily large.

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