Limit of Diversification Gains
We have seen that when two assets with less than perfectly correlated returns are combined in portfolio the variability of return an be reduced without compromising on the level of return. However, investors in hold more than two assets. How does the addition of the third asset to the portfolio affect the portfolio risk (standard deviation)? How far Gin diversification gains be achieved through successive addition of more assets to the portfolio? Is it reduce portfolio risk to zero level just by increasing the number of assets in the portfolio? The answer to these questions depends on the nature of diversification–naive versus Markowitz.