Do well diversified investors consider Stock Y as less risky than Stock X (SDx > SDy and CVx > CVy)?
Is it reasonable that diversified investors regard Stock Y (which has higher standard deviation of return and CV than Stock X) as being less risky than Stock X? Explain.
This is for a college course. Any help much appreciated.
- John WLv 710 years agoFavorite Answer
A lot of people equate a large standard deviation with risk but it simply means volatility and greater probable price movements. I would be more interested in the co-variance since a low co-variance of an investment opportunity with your portfolio would mean less systemic risk and would be a better diversification candidate. Non-systemic risk can be diversified away but not systemic risk. Also a large correlation would mean reducing the size of investment to risk in order to stay under the Kelly Criterion which can be used as a guideline to how much diversification is optimal. Without such a guideline, your best bet is to diversify widely to ensure being well under the Kelly limit. Haven't a clue what answer would get you the grade with your college course, that would really depend on what your instructor thinks is important, you'll need to refer to your course notes to try and determine what methodologies he advocates.