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Harry Markowitz: Founder of Portfolio Theory ppt
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18082012, 02:49 PM
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Harry Markowitz: Founder of Portfolio Theory
[32064] Introduction Harry Markowitz’s “Portfolio Selection” Journal of Finance article (1952) set the stage for modern portfolio theory The first major publication indicating the important of security return correlation in the construction of stock portfolios Markowitz showed that for a given level of expected return and for a given security universe, knowledge of the covariance and correlation matrices are required Terminology Security Universe Efficient frontier Capital market line and the market portfolio Security market line Expansion of the SML to four quadrants Corner portfolio Security Universe The security universe is the collection of all possible investments For some institutions, only certain investments may be eligible E.g., the manager of a small cap stock mutual fund would not include large cap stocks Efficient Frontier Construct a risk/return plot of all possible portfolios Those portfolios that are not dominated constitute the efficient frontier The farther you move to the left on the efficient frontier, the greater the number of securities in the portfolio When a riskfree investment is available, the shape of the efficient frontier changes The expected return and variance of a riskfree rate/stock return combination are simply a weighted average of the two expected returns and variance The riskfree rate has a variance of zero Capital Market Line and the Market Portfolio The tangent line passing from the riskfree rate through point B is the capital market line (CML) When the security universe includes all possible investments, point B is the market portfolio It contains every risky assets in the proportion of its market value to the aggregate market value of all assets It is the only risky assets riskaverse investors will hold Implication for investors: Regardless of the level of riskaversion, all investors should hold only two securities: The market portfolio The riskfree rate Conservative investors will choose a point near the lower left of the CML Growthoriented investors will stay near the market portfolio 
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