ECON351-Chapter5 - ECON 351 Chapter 5 The Theory of...

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1 ECON 351 Chapter 5 The Theory of Portfolio Allocation The theory of portfolio choice outlines the criteria that are important when deciding which assets are worth buying. Determinants of Asset Demand • An asset is a piece of property that has a store of value such as money, bonds, stocks, house… Deciding on which assets will be bought, how much it will be bought, an individual must consider the following factors: – Wealth – Expected return – Risk – Liquidity – Costs of acquiring information Wealth Wealth is total resources owned by individuals. As wealth increases, the quantity of assets we demand increases. Wealth elasticity of demand for an asset: percentage change in quantity demanded of the asset over percentage change in wealth. Luxury good: when wealth elasticity of demand is greater than 1. Necessity good: when wealth elasticity of demand is less than 1.
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2 Expected Returns on Assets • An increase in an asset’s expected return
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