What does the Perold-Sharpe analysis assume?

The Perold-Sharpe analysis, often used in the context of asset allocation and portfolio management, specifically focuses on the relationship between risk and return of different asset classes. The correct interpretation is that it assumes only one of the two asset classes is risky, which allows for a clearer analysis of risk-adjusted returns.

This analysis is predicated on the notion that the risky asset will provide higher expected returns in exchange for greater volatility (risk), while the other asset class is considered risk-free, typically represented by government bonds or cash equivalents. By having one risky asset, the analysis can effectively examine the trade-offs between risk and return, facilitating better investment decisions.

The other considerations surrounding the choices can be elaborated as follows: if both asset classes were risky, that would complicate the analysis since it would introduce multiple sources of risk that would need to be evaluated together, rather than isolating one risk profile. Conversely, asserting that there are no risky asset classes negates the foundation of the Perold-Sharpe analysis, which fundamentally revolves around evaluating risk. Finally, while investment returns being subject to standard deviation is a key concept in finance, it does not directly align with the specific assumptions being made by the Perold-Sharpe analysis, which focuses