Suppose you can invest only in risky Asset B and Asset C that are imperfectly correlated (-1 < R < +1). Suppose further that the means and standard deviations obtainable by varying the fraction f of money invested in Asset B (and hence the fraction (1 – f) of money invested in Asset C) are given by the curve in Figure 4. Which part of the curve is “dominated” and can be ruled out as undesirable? How would you choose where to be on the remaining part of the curve? Please explain your answer.

 

FIGURE 4 Mean Return Imperfect correlation (-1