Question

Briefly explain why the covariance of a security with the rest of a well-diversified portfolio is a more appropriate measure of the risk of the security than the security’s variance.

Answer 1

Answer:

Covariance is a statistical measure that is use for determining the relationship between two variables and its measure the strength of correlation between the twos. A well diversified portfolio is type of portfolio on which all stocks are negatively correlated to each other. The risk of their portfolio is minimal with given level of return. So, in well diversified portfolio, covariance between stock is minimal, that is stock is not much correlated with each other.