question archive 2- Comment on the selection of your stocks in the first week, taking into account the new correlation coefficients information you have calculated in Parti
2- Comment on the selection of your stocks in the first week, taking into account the new correlation coefficients information you have calculated in Parti
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2- Comment on the selection of your stocks in the first week, taking into account the new correlation coefficients information you have calculated in Parti. Would you prefer to select few or less stocks or different stocks in your first week selection process, taking into account the risk diversification concept? 0 Covariance Stock1 stock2 Stock3 Stock4 Stock5 Stock1 15,4839 1,3648 0,6960 11,2091 3,2498 Stock2 1,3648 0,2874 0,1045 1,1670 0,3047 Stock3 0,6960 0,1045 0,1171 0,2394 0,1087 Stock4 11,2091 1,1670 0,2394 11,8555 2,9530 Stock5 3,2498 0,3047 0,1087 2,9530 0,9679 Stock3 Stock 0,8 0,5 Correlation coefficient Stock1 stock2 Stock3 Stock4 Stocks 0,6 Stock1 1,0 0,6 0,5 0,8 0,8 Stock2 0,6 1,0 0,6 0,6 0,6 0,6 1,0 0,2 0,3 Stock5 0,8 0,6 0,3 0,9 1,0 0,2 1,0 0,9
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Diversification is best achieved with negatively correlated stocks in the portfolio. Diversification is also meaningful with uncorrelated stocks.
Examine the table of correlation coefficient:
- All the stocks are positively correlated.
- All the correlation coefficients are positive.
Hence, this portfolio may not be very effective in diversifying away the risk. You therefore need to change the stock mix in your portfolio.
You need to select different stocks. Select those stocks which are uncorrelated or negatively correlated to some of the stocks in your current portfolio. Retain stock 3 and 5 from the current portfolio, they have positive but least correlation coefficient. Replace stock 1, 2 & 4 with those stocks which are uncorrelated or negatively correlated to stock 3 & 5.
