In this video, we’ll take an in-depth look into how portfolio diversification works. We’ll look into idiosyncratic and systematic risks, explore the benefits of diversification and discuss which risks are diversifiable and which aren’t.
At the end, we’ll also play around with an interactive tool that shows a Monte-Carlo simulation for a number of risky assets. The paths are generated using uncorrelated Normal random variables and are compounded arithmetically. The solid white line shows the results for an equally-weighted portfolio consisting of all of the simulated assets.
Using this tool, you can see the effects of diversification – as you increase the number of random assets, the volatility of the portfolio reduces, even though the volatility of each asset in the portfolio remains the same.