Question

What are the primary variables that influence the risk of a portfolio of assets?

According to me the elements that have an impact on the risk of a portfolio are :

1) The correlation of the assets

2) The standard deviation of the asset itself (risk of asset)

3) The weight of the different assets in the portfolio.

The answer on the website suggests that it is:

The maturity, default, seniority and marketability risk but according to me this has an impact on the risk premium from an asset.

Could someone help me out? Kind regards,

Answer 1

Risk of a portfolio is measured by its variance.

Variance for a two-asset portfolio σ_p² = w₁²σ₁² + w₂²σ₂² + 2w₁w₂Cov_1,2

where σ_p² = variance of the portfolio

w₁ = weight of Asset 1

w₂ = weight of Asset 2

σ₁² = variance of Asset 1

σ₂² = variance of Asset 2

Cov_1,2 = covariance of returns between Asset 1 and Asset 2

Cov_1,2 = ρ_1,2 * σ₁ * σ_2, where ρ_1,2 = correlation of returns between Asset 1 and Asset 2

This model can be extended to "n" number of assets to calculate the variance of the portfolio.

Thus, the primary variables that influence the risk of a portfolio of assets are :

1) The correlation of the assets

2) The standard deviation of the asset itself (risk of asset)

3) The weight of the different assets in the portfolio.

Therefore, your answer is correct.

The maturity, default, seniority and marketability risk are variables that influence the risk of a bond. The risk of a bond are maturity risk, default risk and liquidity risk, among others. Thus, these variables primarily influence the risk of a bond, and not a portfolio of assets.