Sunday, November 10, 2013

Variance and standard deviation of perfectly correlated two-stock protfolios

Here's another quick tip, if you're faced with a question regarding a two stock portfolio, if the stocks are perfectly positively correlated. If this is the case, you can save yourself a heap of time by avoiding the long calculation: σ portfolio = [W12σ12 + W22σ22 + 2W1W2σ1σ2r1,2]1/2
If the two stocks, or whatever type of assets, have a correlation of 1.0, then you can simply find a weighted average.

Here's an example: If 30% of an investor's portfolio consists of an asset with a standard deviation of 0.4 and 70% consists of an asset with a standard deviation of 0.2, you can solve for the overall standard deviation of the portfolio like this:
(0.3)(0.4) + (0.7)(0.2) = 0.12 + 0.14 = 0.26
Now isn't that a lot faster than dragging out the long calculation with all those 0's and chances to miss a button. Lets hope there's a question like this on December 7th!