Diversification and Risky Asset Allocation

These flashcards cover key terms and concepts from the lecture notes on diversification and risky asset allocation.

Diversification

The process of spreading investments across different assets to reduce risk.

Expected Return

The weighted average return anticipated from an investment, accounting for various scenarios and their probabilities.

Portfolio Diversification

An investment strategy that encompasses a variety of assets to minimize risk.

Efficient Frontier

The set of optimal portfolios that offer the highest expected return for a defined level of risk.

Risk Premium

The return in excess of the risk-free rate that an investor expects to earn from an investment.

Variance

A measure of the dispersion of returns, indicating the degree of risk associated with the investment.

Standard Deviation

A statistic that measures the extent of deviation of a set of values from their mean, commonly used as a measure of risk.

Correlation

A statistic that indicates the degree to which two securities move in relation to one another.

Portfolio Weights

The proportion of a total portfolio that an individual asset comprises.

Fallacy of Time Diversification

The mistaken belief that holding stocks will become less risky over time due to average returns cancelling out fluctuations.

Imperfect Correlation

The state where asset returns do not move exactly together, enabling risk reduction through diversification.

Economic Scenarios

Possible future states of the economy that influence the returns of securities.

Asset Allocation

The process of dividing investments among different asset categories to optimize risk and return.

Geometric Mean Return

The average rate of return over a period, calculated by multiplying the returns and taking the nth root, used for investment evaluations.