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Diversification

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Diversification :

  • Diversification = the combining of investments with others whose returns are independent of one another.

  • Tends to increase the probability that the EV for the portfolio is close to the sum of the EVs of the individual investments, thereby reducing risk.

  • In practice, most investments are not independent; they are affected by common factors, to some extent.

  • Specific (unsystematic) risk = the risk of an investment arising from factors that are independent of other investment returns.

  • Systematic risk = the risk that is common to most investments.

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