Two assets with a correlation of -1.0 would result in what effect on portfolio risk?

Two assets with a correlation of -1.0 would result in what effect on portfolio risk?

• A. No diversification benefit
• B. Maximum diversification risk reduction
• C. Slight diversification effect
• D. Increases risk

Answer: (B)

Perfect negative correlation means the assets’ returns move in exact opposite directions. When correlation is -1, the covariance term pulls the portfolio variance downward enough that, with the right weights, the overall risk can be driven to zero in theory (assuming the assets’ volatilities align with the weights). This is the maximum diversification benefit because the opposing movements of the assets offset each other as much as possible, minimizing portfolio risk. In practice, exact -1 is rare and differing volatilities make zero risk unlikely, but the principle remains: lower (especially -1) correlation yields greater risk reduction, with -1 offering the maximum possible diversification benefit.

Perfect negative correlation means the assets’ returns move in exact opposite directions. When correlation is -1, the covariance term pulls the portfolio variance downward enough that, with the right weights, the overall risk can be driven to zero in theory (assuming the assets’ volatilities align with the weights). This is the maximum diversification benefit because the opposing movements of the assets offset each other as much as possible, minimizing portfolio risk. In practice, exact -1 is rare and differing volatilities make zero risk unlikely, but the principle remains: lower (especially -1) correlation yields greater risk reduction, with -1 offering the maximum possible diversification benefit.