Expected return - covariance - correlation

Discussion in 'P1.T1. Foundations of Risk (20%)' started by cookies, Aug 7, 2012.

  1. cookies

    cookies New Member

    FRM - Foundation of risk management
    Page 25 - it states that "the portfolio's expected return is unaffected by a change in the correlation"

    Page 26 - explain how covariance and correlation affected the expected return and volatility of portfolio of risky assets

    Could you clarify the meaning? because in page 25, it says it is not affected by a change in the correlation; but in following page, it says it affects E(R)
  2. Hi cookies,

    Page 25 is correct and important: correlation has no impact on expected return

    Page 26 starts with GARP's AIM "Explain how covariance & correlation affect the expected return and volatility of a portfolio of risky assets" .... i'm not crazy in love with the AIM for the soft suggestion otherwise ... but the answer is that covariance and correlation do not affect the expected return. This AIM might be better if it asked "Explain how covariance & correlation affect the volatility of a portfolio of risky assets"

    Note the chart on 26 does not really contradict this: lower correlation manifests as a lower standard deviation for any given return; e.g., moving from red to pink to purple line, but staying on the same horizontal plane (at the same expected return). I hope that explains, thanks,
  3. cookies

    cookies New Member

    awesome - thanks for the clarification! :D
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