Scribd
Upload
9 views13 pages

4 Part2

This document discusses Harry Markowitz's modern portfolio theory and efficient portfolios. It explains how to calculate the efficient frontier by maximizing return for a given risk level or minimizing risk for a given return level. The efficient portfolios on the efficient frontier will be diversified across multiple assets. Examples and exercises are provided.

Uploaded by

arp140102
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
9 views13 pages

4 Part2

This document discusses Harry Markowitz's modern portfolio theory and efficient portfolios. It explains how to calculate the efficient frontier by maximizing return for a given risk level or minimizing risk for a given return level. The efficient portfolios on the efficient frontier will be diversified across multiple assets. Examples and exercises are provided.

Uploaded by

arp140102
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 13

Instructor: Beatriz Balbás Aparicio

[email protected]
CONTENTS
 Harry Markowitz assumptions
 Expected return and variance of a portfolio of assets: Covariance matrix
 Efficient Portfolios and Efficient Frontier
 Introduction of the risk-free asset (RFA) in the Harry Markowitz model
 The Market Portfolio ( ).
 Capital Market Line ( .
 Regression between the risk premium of a portfolio and the market risk
premium.
 The beta and its properties.
 Security Market Line ( ).
 Systematic and specific risk of a portfolio.

2
EFFICIENT PORTFOLIOS AND EFFICIENT FRONTIER
 Once we know how to compute the expected return and the standard
deviation, we take a step further: we look for portfolios with
maximum return at a given risk or portfolios with minimum risk
at a given return. This way we obtain the efficient frontier:

𝟏 𝟏 𝟐 𝟐 𝒏 𝒏
𝒕 𝟏𝟐

𝟏 𝟐 𝒏

 That is, we search for the PARETO’s OPTIMUM.

3
 WHICH ARE, INTUITIVELY, THE PARETO’S OPTIMUM?
 (1) The red portfolio is NOT efficient because there is another portfolio
with MORE EXPECTED RETURN AND LESS RISK.

 (2) The red portfolio is NOT efficient because there is another portfolio
with LESS RISK and EQUAL EXPECTED RETURN.

4
 (3) The red portfolio is NOT efficient because there is another portfolio
with MORE EXPECTED RETURN AND EQUAL RISK.

 (4) This portfolio is EFFICIENT, because there is no other that offers higher
returns and equal risk, or lower risk and equal returns. It can be concluded
that it is a PARETO OPTIMUM.

5
 EXAMPLE 1:
 There are cases of efficient portfolios that cannot be compared.

 Portfolio 𝑥:

𝐸 𝑟 = 20%

𝜎 = 40%

 Portfolio 𝑦:

𝐸 𝑟 = 10%

𝜎 = 30%

 Portfolio cannot be compared with portfolio because portfolio


offers higher profitability, but also higher risk than portfolio .

6
 EXAMPLE 2:
 Portfolio x:

E 𝑟 = 10%

𝜎 = 8%

 Portfolio y:

E 𝑟 = 5%

𝜎 = 9%

 Portfolio is a better portfolio than portfolio , as it offers higher


returns and lower risk.
 This way we obtain the efficient line.

7
 This efficient line is also known as the Markowitz “umbrella”.

 HOW WE CALCULATE THE EFFICIENT FRONTIER?

8
 In order to compute this frontier we have two options:

1. To maximize the portfolio’s expected return at a given


level of risk.

 When we change the values of , we obtain different


portfolios on the efficient line.

9
2. To minimize portfolio’s standard deviation (risk) at a given level
of expected return.
𝒕 𝟏𝟐

𝟏 𝟏 𝟐 𝟐 𝒏 𝒏
𝟏 𝟐 𝒏

 When we change the values of (we obtain different portfolios on


the efficient line.

 ALL THE PORTFOLIOS OF THE EFFICIENT LINE WILL BE VERY


DIVERSIFIED .

 Every convex optimization problem (the function is convex) leads to diversified


results. So we would not obtain 𝑥1 = 1 and 𝑥2 = 0 or 𝑥1 = 0 and 𝑥2 = 1, but, for
instance, 𝑥1 = 0,5 and 𝑥2 = 0,5 or 𝑥1 = 0,3 and 𝑥2 = 0,7.

10
 In practice, the problem solved is

 Or

 We will only solve the equality, since otherwise the K-K-T conditions
would be involved, and the problem solution would be more tedious.

11
EXERCISES 1, 2, 3, 4, 5

12
Instructor: Beatriz Balbás Aparicio
[email protected]

You might also like