Portfolio Variance

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DEFINITION of 'Portfolio Variance'

The measurement of how the actual returns of a group of securities making up a portfolio fluctuate. Portfolio variance looks at the standard deviation of each security in the portfolio as well as how those individual securities correlate with the others in the portfolio. In other words, portfolio variance looks at the covariance or correlation coefficient for the securities in the portfolio. Generally, the lower the correlation between securities in a portfolio, the lower the portfolio variance.

BREAKING DOWN 'Portfolio Variance'

Portfolio variance is calculated by multiplying the squared weight of each security by its corresponding variance and adding two times the weighted average weight multiplied by the covariance of all individual security pairs. Modern portfolio theory says that portfolio variance can be reduced by choosing asset classes with a low or negative correlation, such as stocks and bonds. This type of diversification is used to reduce risk.

Portfolio variance = (weight(1)^2*variance(1) + weight(2)^2*variance(2) + 2*weight(1)*weight(2)*covariance(1,2)

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