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Finance Concepts Explained
Capital Markets & Investments at Columbia Business School | Simon Oh

Finding the Optimal Portfolio

How to combine risky assets and why correlation matters

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The Two-Asset Portfolio

  • Consider two risky assets:
  • Stock A: E(r) = 14%, σ = 20%
  • Stock B: E(r) = 8%, σ = 15%
  • How should you allocate between them? The answer depends critically on how they move together—their correlation.
0%5%10%15%20%25%2%4%6%8%10%12%14%16%Volatility (σ)Expected ReturnStock Bσ=15%, E(r)=8%Stock Aσ=20%, E(r)=14%
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