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

Nicole Seaman

Director of FRM Operations
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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: http://trtl.bz/frm-t1-7-ppc-xls


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