If we invest $w$ in the market portfolio and $1 - w$ in the risk-free asset, and observe a $0$-beta asset with expected return greater than the return on the risk-free asset, how can this be used in diversification to reduce risk?
My initial confusion is due to the expected return being greater than the risk-free asset. In equilibrium (i.e., CAPM), this is not possible since the expected returns on the two should be equal?
