SOME PORTFOLIO-RELEVANT RISK CHARACTERISTICS OF LONG-TERM MARKETABLE SECURITIES.

The attractiveness of a security in a portfolio context depends upon both the raturns it is expected to generate and the interrelationship of these returns with those of other securities in the portfolio. Return relationships may be appraised directly; they may also be examined indirectly by reference to the relationship between the individual return streams and an external factor. The investigation discussed in the first section of this paper suggests that there is some evidence that the ex post return volatility with respect to changes in the level of business activity increases algebraically as one moves from U.S. government bonds to corporate bonds, preferred stock, public utility common stock, and finally to industrial common stock. Despite the consistency of this rank ordering with a priori conceptions of security riskiness, direct estimation of security return interrelationships is found to be more useful for the construction of diversified portfolios. Assuming that the 1951-1968 experience is in fact representative of the "true" return interrelationships, a proposition, which has been suggested by others, is confirmed empirically — the return variability or "risk" of portfolios composed solely of low risk security types may be reduced by diversification of the portfolio with security types which in isolation are considered to be high in risk. More specifically, the empirical investigation suggests that the return variability of portfolios of government bonds and/or corporate bonds may be reduced by the judicious introduction of industrial common stocks into the portfolios. At the other end of the risk spectrum, there is some evidence that the risk of common stock portfolios may be reduced most economically (in terms of foregone returns) by diversification with government bonds. Perhaps the most interesting aspect of these results focuses on the extent to which government bonds and common stocks meld well together in a portfolio, whereas corporate... [ABSTRACT FROM AUTHOR]