Modern Portfolio Theory
History
- Harry Markowitztodo research a bit
- balance risk and return
- just highest expected return is not reasonable
- utility is more important
- optimal portfolio = minimal risk for a given return
- or maximum return for a given risk
- ground work for modern theory
- expected return = average of historical returns
- no sensible prediction possible
- volatilityslides 76
- diversificationslides 76
- uncorrelated stocks are not affected by same risks
Optimal Portfolio
Simplified Model
Portfolio Frontier
- only 2 stocks
- perfect correlation … line between 2 portfolios
- perfect non-correlation … line between a … y-axis and y-axis b
- non-extreme correlation … curved line between a and b to the left of perfect correlation function
- more than 2 stocks
- a region encompassing all stocks
- looks a bit like a right/left flipped D
- efficient frontier
- only part of the portfolio frontier is efficient (optimal)
- part is the monotonously increasing (upper) part of the portfolio frontier curve
Investor Preference
- Indifference Curve and efficient portfolio line are tangent
- indifference curve dependent on preferences of investor
- the intersection is the optimal choice of an investor
- called a “tangency portolio”