YouTube T1-7 How the portfolio possibilities curve (PPC) illustrates the benefit of diversification

Nicole Seaman

Director of FRM Operations
Staff member
When correlations are imperfect, diversification benefits are possible. The portfolio possibilities curve illustrates this and it contains two notable points: the minimum variance portfolio (MVP) and the optimal portfolio (with the highest Sharpe ratio), At the end, I summarize four features of the PPC: 1. correlation, ρ, determines the shape of the PPC; 2. The minimum variance portfolio (MVP) is furthest left (and has an easy analytical solution); 3. The (MVP) also slices the PPC into a lower convex segment and an upper concave segment which contains the dominating efficient portfolios; and 4. The theoretically optimal portfolio has the highest Sharpe ratio (and also has an analytical albeit less easy solution).

Here is David's XLS:

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