Market model

Chapter 7 Why Diversification Is a Good Idea

[object Object],[object Object],[object Object]

Outline ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Introduction ,[object Object],[object Object]

Carrying Your Eggs in More Than One Basket ,[object Object],[object Object],[object Object]

Investments in Your Own Ego ,[object Object],[object Object],[object Object],[object Object]

The Concept of Risk Aversion Revisited ,[object Object],[object Object],[object Object],[object Object],[object Object]

The Concept of Risk Aversion Revisited (cont’d) ,[object Object],[object Object],[object Object]

Multiple Investment Objectives ,[object Object],[object Object],[object Object],[object Object]

Role of Uncorrelated Securities ,[object Object],[object Object],[object Object],[object Object]

Variance of A Linear Combination ,[object Object],[object Object]

Variance of A Linear Combination (cont’d) ,[object Object]

Variance of A Linear Combination (cont’d) ,[object Object],[object Object],Total Risk Risk from A Risk from B Interactive Risk

Variance of A Linear Combination (cont’d) ,[object Object],[object Object],[object Object]

Portfolio Programming in A Nutshell ,[object Object],[object Object]

Portfolio Programming in A Nutshell (cont’d) ,[object Object],[object Object],Stock A Stock B Stock C Expected return .20 .14 .10 Standard deviation .232 .136 .195

Portfolio Programming in A Nutshell (cont’d) ,[object Object],[object Object],Stock A Stock B Stock C Stock A 1.000 Stock B 0.286 1.000 Stock C 0.132 -0.605 1.000

Portfolio Programming in A Nutshell (cont’d) ,[object Object],[object Object],[object Object]

Portfolio Programming in A Nutshell (cont’d) ,[object Object],[object Object],[object Object],[object Object]

Portfolio Programming in A Nutshell (cont’d) ,[object Object],[object Object]

Concept of Dominance ,[object Object],[object Object]

Concept of Dominance (cont’d) ,[object Object],[object Object],[object Object]

Concept of Dominance (cont’d) ,[object Object],[object Object],Risk Expected Return B/C combination dominates A/C

Harry Markowitz: Founder of Portfolio Theory ,[object Object],[object Object],[object Object]

Introduction ,[object Object],[object Object],[object Object]

Terminology ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Security Universe ,[object Object],[object Object],[object Object]

Efficient Frontier ,[object Object],[object Object]

Efficient Frontier (cont’d) Standard Deviation Expected Return 100% investment in security with highest E(R) 100% investment in minimum variance portfolio Points below the efficient frontier are dominated No points plot above the line All portfolios on the line are efficient

Efficient Frontier (cont’d) ,[object Object]

Efficient Frontier (cont’d) ,[object Object],[object Object],[object Object]

Efficient Frontier (cont’d) Standard Deviation Expected Return R f A B C

Efficient Frontier (cont’d) ,[object Object],[object Object],[object Object],[object Object]

Capital Market Line and the Market Portfolio ,[object Object],[object Object],[object Object],[object Object]

Capital Market Line and the Market Portfolio (cont’d) ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Capital Market Line and the Market Portfolio (cont’d) ,[object Object],[object Object]

Capital Market Line and the Market Portfolio (cont’d) Standard Deviation Expected Return R f A B C

Security Market Line ,[object Object],[object Object],[object Object]

Security Market Line (cont’d) Beta Expected Return R f Market Portfolio 1.0 E(R)

Expansion of the SML to Four Quadrants ,[object Object],[object Object],[object Object],[object Object]

Security Market Line (cont’d) Beta Expected Return Securities with Negative Expected Returns

Corner Portfolio ,[object Object],[object Object]

Quadratic Programming ,[object Object],[object Object],[object Object]

Markowitz Quadratic Programming Problem

Lessons from Evans and Archer ,[object Object],[object Object],[object Object],[object Object],[object Object]

Introduction ,[object Object],[object Object],[object Object],[object Object]

Methodology ,[object Object],[object Object],[object Object]

Results ,[object Object],[object Object],[object Object],[object Object],[object Object]

Definitions ,[object Object],[object Object],[object Object]

Definitions (cont’d) ,[object Object],[object Object],[object Object],[object Object]

General Results Number of Securities Portfolio Variance

Strength in Numbers ,[object Object],[object Object],[object Object]

Biggest Benefits Come First ,[object Object],[object Object],[object Object]

Superfluous Diversification ,[object Object],[object Object],[object Object]

Implications ,[object Object],[object Object],[object Object]

Implications (cont’d) ,[object Object],[object Object]

Words of Caution ,[object Object],[object Object],[object Object],[object Object]

Diversification and Beta ,[object Object],[object Object],[object Object],[object Object],[object Object]

Capital Asset Pricing Model ,[object Object],[object Object],[object Object]

Systematic and Unsystematic Risk ,[object Object],[object Object],[object Object],[object Object]

Fundamental Risk/Return Relationship Revisited ,[object Object],[object Object],[object Object],[object Object],[object Object]

CAPM (cont’d) ,[object Object],[object Object],[object Object],[object Object]

CAPM (cont’d) ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

CAPM (cont’d) ,[object Object],[object Object],[object Object]

SML and CAPM ,[object Object],[object Object],[object Object]

Market Model Versus CAPM ,[object Object],[object Object],[object Object],[object Object]

Market Model Versus CAPM (cont’d) ,[object Object]

Note on the CAPM Assumptions ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Stationarity of Beta ,[object Object],[object Object],[object Object],[object Object]

Equity Risk Premium ,[object Object],[object Object],[object Object]

Using A Scatter Diagram to Measure Beta ,[object Object],[object Object],[object Object],[object Object]

Correlation of Returns ,[object Object],[object Object],[object Object],[object Object]

Linear Regression and Beta ,[object Object],[object Object],[object Object],[object Object],[object Object]

Importance of Logarithms ,[object Object],[object Object],[object Object]

Statistical Significance ,[object Object],[object Object],[object Object]

Arbitrage Pricing Theory ,[object Object],[object Object],[object Object]

APT Background ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

APT Background (cont’d) ,[object Object],[object Object]

The APT Model ,[object Object]

Comparison of the CAPM and the APT ,[object Object],[object Object],[object Object],[object Object]

Comparison of the CAPM and the APT (cont’d) ,[object Object],[object Object]

Market model

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