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← The Free Lunch of Diversification
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Question
Two assets each have 15% annual volatility and zero correlation. What is the approximate volatility of an equal-weight portfolio of the two?
1
7.5%, because the risks simply average together
2
15%, because diversification does not affect volatility when assets have the same individual risk
3
Approximately 10.6%, because the portfolio variance formula with zero correlation gives √(0.5² × 15² + 0.5² × 15²)
4
0%, because zero correlation means the assets perfectly offset each other
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