old Exam 9, 2008 #10

[gaddy]

b) Briefly describe the condition under which the marginal surplus required when adding a new risk to an existing portfolio will be a function of the variance of the new risk.

c) function of std dev.

Answer is when completely uncorrelated (C=0) for b, perfectly correlated (C=1) for c.

But, isn't the point of the paper to show that marginal surplus really depends on the covariance between the new risk and the current portfolio? Thus, wouldn't marginal surplus depend on some linear combo of std dev and variance of the new risk? I know Goldfarb says this, but is it implied in a strong enough manner to work on the exam? My answers were b) any time other than when C=1 (I described the covariance thing and showed the equation for marginal standard deviation when C=1); and c) any time other than C=0.