13 views

Uploaded by vis_mad

- as
- Country, Industry and Factor Risk Loading in Portfolio Management
- merger and acquisition concept
- 2389 TheEnviableDilemma BB
- LBMA - Speech by Ashish Bhatia on Central Bank Demand for Gold
- Portfolio 8
- Realty Deep Analysis Part 1
- Portfolio Problem
- Restructuring
- Financial Management in Construction
- SAPM Module 7
- EXAM 1 IPM Solutions Spring 2012(b)
- Finance 2
- portfolio Risk.pptx
- Lecture 12
- Diario 26 - Ranking de los países más seguros e inseguros
- Making Slow but Undeniable Progress
- Final Review
- Hedge Fund Redemptions and Fund Failures
- $PIMCO Clarida El-Erian Uncertainty Changing Investment Landscape 8-2-10

You are on page 1of 32

1

O! This learning, what a thing it is!

- William Shakespeare

2

Outline

Introduction

Linear combinations

Single-index model

Multi-index model

3

Introduction

Thereason for portfolio theory

mathematics:

• To show why diversification is a good idea

logically

4

Introduction (cont’d)

Harry Markowitz’s efficient portfolios:

• Those portfolios providing the maximum return

for their level of risk

for a certain level of return

5

Linear Combinations

Introduction

Return

Variance

6

Introduction

A portfolio’s performance is the result of

the performance of its components

• The return realized on a portfolio is a linear

combination of the returns on the individual

investments

combination of component variances

7

Return

The expected return of a portfolio is a

weighted average of the expected returns of

the components:

n

E ( R p ) xi E ( Ri )

i 1

invested in security i and

n

x

i 1

i 1

8

Variance

Introduction

Two-security case

Minimum variance portfolio

Correlation and risk reduction

The n-security case

9

Introduction

Understanding portfolio variance is the

essence of understanding the mathematics

of diversification

• The variance of a linear combination of random

variables is not a weighted average of the

component variances

10

Introduction (cont’d)

Foran n-security portfolio, the portfolio

variance is:

n n

xi x j ij i j

2

p

i 1 j 1

ij correlation coefficient between

Security i and Security j

11

Two-Security Case

Fora two-security portfolio containing

Stock A and Stock B, the variance is:

x x 2xA xB AB A B

2

p

2

A

2

A

2

B

2

B

12

Two Security Case (cont’d)

Example

Stock A Stock B

Expected return .015 .020

Variance .050 .060

Standard deviation .224 .245

Weight 40% 60%

Correlation coefficient .50

13

Two Security Case (cont’d)

Example (cont’d)

security portfolio?

14

Two Security Case (cont’d)

Example (cont’d)

portfolio is: n

E ( R p ) xi E ( Ri )

i 1

x A E ( RA ) xB E ( RB )

0.4(0.015) 0.6(0.020)

0.018 1.80%

15

Two Security Case (cont’d)

Example (cont’d)

portfolio is:

(.4) (.05) (.6) (.06) 2(.4)(.6)(.5)(.224)(.245)

2 2

.0428 16

Minimum Variance Portfolio

The minimum variance portfolio is the

particular combination of securities that will

result in the least possible variance

requires basic calculus

17

Minimum Variance

Portfolio (cont’d)

Fora two-security minimum variance

portfolio, the proportions invested in stocks

A and B are:

A B AB

2

xA 2 B

A B 2 A B AB

2

xB 1 x A

18

Minimum Variance

Portfolio (cont’d)

Example (cont’d)

previous example. What are the weights of the minimum

variance portfolio in this case?

19

Minimum Variance

Portfolio (cont’d)

Example (cont’d)

in this case are:

B2 A B AB .06 (.224)(.245)(.5)

xA 2 59.07%

A B 2 A B AB .05 .06 2(.224)(.245)(.5)

2

xB 1 xA 1 .5907 40.93%

20

Minimum Variance

Portfolio (cont’d)

Example (cont’d)

1.2

0.8

Weight A

0.6

0.4

0.2

0

0 0.01 0.02 0.03 0.04 0.05 0.06

Portfolio Variance 21

Correlation and

Risk Reduction

Portfolio risk decreases as the correlation

coefficient in the returns of two securities

decreases

Risk reduction is greatest when the

securities are perfectly negatively correlated

If the securities are perfectly positively

correlated, there is no risk reduction

22

The n-Security Case

For an n-security portfolio, the variance is:

n n

xi x j ij i j

2

p

i 1 j 1

ij correlation coefficient between

Security i and Security j

23

The n-Security Case (cont’d)

The equation includes the correlation

coefficient (or covariance) between all pairs

of securities in the portfolio

24

The n-Security Case (cont’d)

A covariance matrix is a tabular

presentation of the pairwise combinations of

all portfolio components

• The required number of covariances to compute

a portfolio variance is (n2 – n)/2

full covariance matrix is called a Markowitz

model

25

Single-Index Model

Computational advantages

Portfolio statistics with the single-index

model

26

Computational Advantages

Thesingle-index model compares all

securities to a single benchmark

• An alternative to comparing a security to each

of the others

behave relative to a third value, we learn

something about how the securities are likely to

behave relative to each other

27

Computational

Advantages (cont’d)

A single index drastically reduces the

number of computations needed to

determine portfolio variance

• A security’s beta is an example:

COV ( Ri , Rm )

i

m2

where Rm return on the market index

m2 variance of the market returns

Ri return on Security i

28

Portfolio Statistics With the

Single-Index Model

Beta of a portfolio:

n

p xi i

i 1

Variance of a portfolio:

2p p2 m2 ep2

p2 m2

29

Portfolio Statistics With the

Single-Index Model (cont’d)

Variance of a portfolio component:

i

2

i

2 2

m

2

ei

AB A B m2

30

Multi-Index Model

A multi-index model considers independent

variables other than the performance of an

overall market index

• Of particular interest are industry effects

– Factors associated with a particular line of business

companies in a recession

31

Multi-Index Model (cont’d)

The general form of a multi-index model:

Ri ai im I m i1 I1 i 2 I 2 ... in I n

where ai constant

I m return on the market index

I j return on an industry index

ij Security i's beta for industry index j

im Security i's market beta

Ri return on Security i

32

- asUploaded byAlok Tripathi
- Country, Industry and Factor Risk Loading in Portfolio ManagementUploaded byFazry Sidiq
- merger and acquisition conceptUploaded byMẹdạy Đặttên Đừng Quádài
- 2389 TheEnviableDilemma BBUploaded bymircea
- LBMA - Speech by Ashish Bhatia on Central Bank Demand for GoldUploaded byGreg McKenna
- Portfolio 8Uploaded bySaloni Neelam
- Realty Deep Analysis Part 1Uploaded bybs_active
- Portfolio ProblemUploaded byAshutosh Kumar
- RestructuringUploaded byNicky Nyamasyo
- Financial Management in ConstructionUploaded bySoufiane Ouaadidy
- SAPM Module 7Uploaded byAnvibha
- EXAM 1 IPM Solutions Spring 2012(b)Uploaded bykiffeur69
- Finance 2Uploaded byaiza
- portfolio Risk.pptxUploaded byABC DEF
- Lecture 12Uploaded byRahim Mardhani
- Diario 26 - Ranking de los países más seguros e insegurosUploaded byDiario26.com
- Making Slow but Undeniable ProgressUploaded byAmerican Century Investments
- Final ReviewUploaded byMatthew Shinsato
- Hedge Fund Redemptions and Fund FailuresUploaded bydancastro1
- $PIMCO Clarida El-Erian Uncertainty Changing Investment Landscape 8-2-10Uploaded byunzane
- ProjectUploaded byseepi345
- School March10Uploaded byRotaru
- 11 Economics Impq Ch07 CorrelationUploaded bynivedita_h42404
- FPIUploaded byArun Sharma
- A Causal Relationship Between Stock Indices and Exchange Rates Empirical Evidence From IndiaUploaded byAlexander Decker
- Understanding Asset Allocation VRK100 14Oct2012Uploaded byRamaKrishna Vadlamudi, CFA
- User Manual for YASAIwUploaded bygg
- UntitledUploaded byapi-236467720
- Chapter 8 Unit 8Uploaded bycutefeet
- Bernie Schaeffer’s Option AdvisorUploaded bysomeshol

- Chap_01_Marlin_2013.pptUploaded byNabila Agnasia Desmara
- Space Engineering Question Bank 04.04.2018Uploaded bysanjay
- Logical Modeling SDLCUploaded byShri
- P3d208Uploaded byFrancisco Santibañez
- Rethinking AnimismUploaded byDaniele Ferreira
- Managerial EconomicsUploaded byCyril James
- Analisa eviewsUploaded byMuhammad Satria Priyantama
- todiniUploaded byEdwin Aranda Saldaña
- Guidelines for Validation Radiation SterilizationUploaded bymarcosbrefe
- HDIUploaded bySandra Mohamed
- Drivers Read Me Le NovoUploaded byEddie Muñoz
- Unix File SystemUploaded bybindumishra
- Fault List.pdfUploaded byAristóteles Terceiro Neto
- math 1010 optimization project 1Uploaded byapi-260112606
- Gnawing ZombieUploaded byHuiqi
- Pithon GuideUploaded byGiora Shay
- IUSS Bulletin #124 (May 2014)Uploaded byScary Creatures
- Goodchk HinduUploaded byIhtesham Hassan
- Install Monitorix Di Debian 6 SqueezeUploaded byPendekar Blank
- honors experiential learning project proposalUploaded byapi-266336110
- Rahul Jain - CVUploaded byDarshan Joshi
- flow in filmUploaded byCynthia Robinson
- Captain Underpants, Satire and the Literary EstablishmentUploaded byKriti Chester Talwar
- MUJ CV 2Uploaded bymujeeb600
- Customer SatisfactionUploaded byNageshwar Singh
- 2016-2017 MALDEF Scholarship ListUploaded byVanessa
- Unit 3 Ergonomics OutlineUploaded bydasmith100
- RAC Server Pools What's New in Oracle 12cUploaded byanoop666r
- LinuxCBT EL-5 Edition NotesUploaded byVishesh Kumar
- BerndFreibottArticle.pdfUploaded byArmelyndaBeverly