0 Up votes0 Down votes

7 views33 pagesMar 14, 2011

© Attribution Non-Commercial (BY-NC)

PPT, PDF, TXT or read online from Scribd

Attribution Non-Commercial (BY-NC)

7 views

Attribution Non-Commercial (BY-NC)

- ch21
- 2009 July 23 Buy High Sell Low
- Risk Analysis in Port Finance
- About NPS
- 23 Wac Report3
- Tema 4_2_Eng
- 5 Ways to Diversify Your Portfolio
- Nota Keusahawanan Week 2 (Environment Screening) Edited 20 Sep 2012
- 5536_1
- Arbor i Decision Ali
- Accenture Retail Industry Report
- 2015_ISO_9001_Review_Mar2014
- Mediolanum taxfree
- Art RiskAnalysis ISO31000
- 13cf015127 bailey charles.docx
- Group Project 5
- DT Syllabus 15
- Visualising Success 141208165352 Conversion Gate02
- FINS3616 Group Project 1
- ch08 TB

You are on page 1of 33

Portfolio Management

Lecture 1: A simple model of portfolio

management

|2

Investment objective, risk

tolerance & strategy

(Class 3,4,5) (Class 8, 9, 10)

(Class 6&7) (Class 11 & 12)

Performance measurement

& evaluation (class 13& 14)

|3

› Risk is probably the most ambiguous element of

modern portfolio theory and asset choice.

› People tend to confuse their risk expectations with

their risk attitude.

› Risk attitude can be modelled using utility functions.

› Risk tolerance is the willingness of people to bear risk

in excange for return (risk premium)

The efficient frontier

|4

Utility function

Return

Opportunity set of investment

Alternatives that present

Rational choices for risk

Averse investors

Risk

|5

› U(W) utility function representing the utility of wealth W

system

|6

› In the past, the following was used in counting soccer

scores in a tournament:

Win 2

Tie 1

Loss 0

|7

› A common way of counting soccer scores in a

tournament is by using the following system:

Win 3

Tie 1

Loss 0

|8

› Consider two equally strong teams, that use a

different strategy:

1. The first team plays a risky strategy involving an

offensive playing style

2. This team plays a conservative strategy involving a

defensive playing style.

|9

› Suppose that team 1 has a 50% probability of winning and a 50%

probability of losing

› Suppose that team 2 has a 10% probability of winning, an 80%

probability of an equal outcome, and a 10% probability of

loosing.

› Team 1: has 5*3 = 15 points (old score: 10)

› Team 2: has 1*3 + 8*1 = 11 points (old score: 10)

| 10

σ 2

f = E[ R] −

T

where T represents the risk tolerance, R is the

return on a portfolio and σ is its standard deviation

| 11

› We like to choose a portfolio of stocks and riskless bonds

that maximizes our utility.

› Rs is the return on stocks, Rf is the return on bonds, and σs

is the standard deviation of stock returns.

› Let x be the fraction of assets in stocks.

› We want to choose x in such a way that we maximize our

utility f:

x 2σ 2

max f = ( xRs + (1 − x ) R f ) −

s s

T

| 12

For example:

= ( Rs − R f ) − x σ 2 = 0

df 2

s s Rs 12%

dx T

T Rs − R f Rf 8%

xs =

2 σ2 s Sigma 20%

T=1

x=5

0%

| 13

Allocation to risky assets

1.2

0.8

Risky asset

0.6

0.4

0.2

0

0 0.5 1 1.5 2 2.5

Risky tolerance

| 14

› Design questionairres and interview individuals

(expected)

› Implicitly derive it from portfolio data (realized)

› We need to know the

1. Risk of the risky assets

2. The risk premium

3. The allocation to risky assets

| 15

› Following the implicit method

› According to Dimson et al, the equity risk premium is

somewhere between 3.5% and 5.25%.

› Risk estimates for the stock market index are between

18% and 25%.

For a fully invested investor

σ2

=T

s

2 xs

Alloca

Rs − R f

| 16

Rational:

› Risk tolerance (or inversely risk aversion)

› Risk premium

› Riskiness of the asset

Psychological:

› Perception of risk

| 17

Risk premium

› 1990-1999: US investor achieved total return of 14.2%

per annum

› 1926-2000: US investor achieved an equity risk

premium of 7.3%

› UK, 1919-1999: UK investor achieved an equity risk

premium of 6.4%

• survivorship bias

• only 2 markets from the 36.

| 18

| 19

› Risk premium:

• Lowest: 2.2% (gmt) or 4.4% (arm) for Belgium

• Highest 6.8% (gmt) or 8.3% (arm) for Australia

› So estimates range from 16.5% to 35.5% for the

standard deviation

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

3-1-2000

3-4-2000

3-7-2000

3-10-2000

3-1-2001

3-4-2001

3-7-2001

3-10-2001

3-1-2002

3-4-2002

3-7-2002

3-10-2002

3-1-2003

3-4-2003

3-7-2003

3-10-2003

VAEX

3-1-2004

3-4-2004

3-7-2004

3-10-2004

3-1-2005

3-4-2005

3-7-2005

3-10-2005

3-1-2006

3-4-2006

3-7-2006

Expected risk: implied volatility

3-10-2006

3-1-2007

3-4-2007

3-7-2007

| 20

| 21

Different beliefs

› Even persons with the same risk tolerance could hold

very different portfolios if their expectations are

different.

T 1 1 1 1

Rs-Rf 4% 8% 2% 4%

Sigma 15% 20% 25% 25%

| 22

risk tolerance

Rs-Rf 4% 4% distinguish between

Sigma 15% 30% these two concepts?

Risky asset 22% 22% Is risk tolerance

affected by previous

high volatility on the

stock market?

| 23

Strategy

› Brinson & Fachler: study of pension fund

performance measurement

› What factors impact the realized performance?

› Top down model

1. Strategic asset allocation

2. Tactical asset allocation

3. Security selection (stock picking)

| 24

› The long-term asset allocation choosen by an investor in

terms of

• the allocation over stocks, bonds, real estate

• different geographical regions

› Reflects the main risk-profile of the investor

• This is the asset allocation that is recommended by

banks to their customers after filling in the risk-

questionaire

• Pension funds use an ALM study to find out what asset

allocation serves their long-term goals.

| 25

› Reflects the actual current asset allocation

› Differs from the strategical asset allocation because

• Asset classes perform differently (so you have to

rebalance to maintain the strategic asset

allocation)

• Reflect the market view of the investor (US stocks

will recover in the next period, so we increase the

weight to profit from this.

| 26

1. The benchmark portfolio;

2. The stock-selected portfolio;

3. The timing portfolio;

4. The actual portfolio.

› Portfolio 1 is the overall benchmark portfolio, which

is derived directly from the general investment

plan.

› Portfolios 2 and 3 are the outcomes of a ‘what if

analysis’ that measure the impact of decisions in

isolation from other decisions.

| 27

Measurement:

R(I) = ∑ w ip R ip R(III) = ∑ w ia R ip

i i

i i

Source Calculation

Timing R(III) -R(I) Σ (wip - wia) Rip

Selection R(II) -R(I) Σ (Ria - Rip) wip

Interaction R(I)-R(II)-R(III) + R(IV) Σ wip (Rip - Ria) +wia (Ria-Rip)

Total contribution R(IV) -R(I) Ra- Rp

| 28

Example

An investor utilizes a strategic asset allocation of

• 50% bonds

• 20% domestic stocks

•30% foreign stocks

benchmark portfolio

Bond 30% 8% 7%

Domestic stocks 20% 12% 15%

Foreign stocks 50% 24%* 22%*

| 29

Outcome:

Portfolio Return

I 13.6% Timing 3.2%

II 13.1% Selection -0.5%

III 16.8% Interaction -0.2%

IV 16.1% Total contribution 2.5%

| 30

| 31

| 32

| 33

Lessons to be learned

› Strategic asset allocation / the allocation to choose the

level of risk is the most important decision in the

investment portfolio and explains more than 90% of

differences in return between portfolios.

› Tactical asset allocation and stock selection contribute

little to total outperformance.

› Decision to choose level of risk depends on a number

of subjective variables, such as risk tolerance,

expected return, and risk.

- ch21Uploaded byJunaid Jamshaid
- 2009 July 23 Buy High Sell LowUploaded bymedinleal
- Risk Analysis in Port FinanceUploaded bySwati Jain
- About NPSUploaded byRikesh Patel
- 23 Wac Report3Uploaded byKunal Kaushal
- Tema 4_2_EngUploaded byOlesea Dobrovolscaia
- 5 Ways to Diversify Your PortfolioUploaded byvineetksr
- Nota Keusahawanan Week 2 (Environment Screening) Edited 20 Sep 2012Uploaded byMazliah Zainal Abidin
- 5536_1Uploaded byTopala Sorin
- Arbor i Decision AliUploaded byIrina Alexandra
- Accenture Retail Industry ReportUploaded bymohammedumair
- 2015_ISO_9001_Review_Mar2014Uploaded byAbd Zouhier
- Mediolanum taxfreeUploaded bycarpa88
- Art RiskAnalysis ISO31000Uploaded byeescobarv
- 13cf015127 bailey charles.docxUploaded byIwuoha Maxrofuzo Chibueze
- Group Project 5Uploaded byJoel Jankulovski
- DT Syllabus 15Uploaded byLuisSanchez
- Visualising Success 141208165352 Conversion Gate02Uploaded byjmezap
- FINS3616 Group Project 1Uploaded byRuben Collins
- ch08 TBUploaded byمريمالرئيسي
- Hoja de RiesgoUploaded byAdriana Beizaga
- Assignment QuestionnaireUploaded byz_k_j_v
- Classical Asset Allocation - Combining Markowitz and MomentumUploaded byKofi Appiah-Danquah
- fficeUploaded byAviR14
- Investment Decision Making and RiskUploaded bykylie man
- G Risk RegisterUploaded bySamuel Kagoru Gichuru
- 5_6339119154754224196.pptxUploaded byUwais
- Value Based PerformanceUploaded bykujo2k
- Risk Assessment - CHW Pump.docxUploaded byAdnan Attish
- Alternative Invesmtents for Pension FundsUploaded byQuantmetrix

- portfolio construction.docxUploaded byRonak Gosalia
- SM CFAsolutions Reilly1ceUploaded bysky_61292
- Extension in closing date (PEMF-I).pdfUploaded byDabeer Khan
- Bis Fx Reserve MgmtUploaded bysdfe12
- Vol 39Uploaded byANKIT_XX
- Investment StrategyUploaded bybilu4u
- PIMCO in Depth Bhansali Inflation Tail Risk Hedging May2013Uploaded byrpcampbell
- Annual Report 2011-12Uploaded byershad123
- Common Application Form PltvfequityUploaded byAshutosh Upadhyay
- Financial InvestmentsUploaded byOraine Campbell
- Alternative Investment Analyst ReviewUploaded byRodolpho Cammarosano de Lima
- MC-0719Uploaded bymcchronicle
- U740046133 (1)Uploaded byDaniel Copeland
- Risk Profile QuestionnaireUploaded bySanaullah Bughio
- Global Family Offices SampleUploaded bydsrkim
- Portfolio DiversificationUploaded byhardik_jnv
- Understanding KSTUploaded byAforArijit BforBanerjee
- R. Driehaus, Unconventional Wisdom in the Investment ProcessUploaded bybagelboy2
- AMBUTFUploaded byckzeo
- An Overview on Potfolio MgntUploaded byHarikrishnan Nair
- Parametric Portfolio Policy using Currencies as an Asset ClassUploaded byArnar Ingi Einarsson
- Man.Invest Chap 006 pptUploaded byyola
- Essential of investment test bank chapter 1Uploaded byanthony9637
- Amplify Trading Career Programme 2014(5)Uploaded bylanja
- 1 Naseem BegUploaded byPunjabi Larka
- Efficiency and Performance of BulgarianUploaded bymerylind
- A-New-Foundation-for-Portfolio-Management.pdfUploaded byIchbin Bin
- CFP Mock Test Investment PlanningUploaded byDeep Shikha
- jurnal akuntansi islamUploaded byCondro Triharyono
- 2009 Low Res Annual Report - Full CopyUploaded bykasrahed

## Much more than documents.

Discover everything Scribd has to offer, including books and audiobooks from major publishers.

Cancel anytime.