Fall 2017 ACTSC 613 Zhu, M

University of Waterloo
ACTSC 613

Problem of the Week, #4

( Distributed: October 3, 2017; Due: October 12, 2017 )

1. Suppose you are investing in a very simple market with only two available assets: A and B.
Let RA and RB denote their respective returns. Then, the return of your portfolio is given
by
R̄ ≡ wRA + (1 − w)RB ,
where w is the percent that you decide to invest in A. If Var(RB ) = 2Var(RA ), find the
portfolio allocation (w, 1 − w) that minimizes Var(R̄), assuming

(a) Corr(RA , RB ) = 0;
(b) Corr(RA , RB ) = 0.1;
(c) Corr(RA , RB ) = −0.1.

Remark: Here, we are not considering any requirement on E(R̄), the expected return of your
portfolio, in order to simplify the matter. Alternatively, you can also think of this market as
one in which the expected returns of A and B are the same; then, the expected return of your
portfolio does not depend on how you invest (but the variance of the return still does).

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