Lecture 10- Modern Portfolio Theory

Lecture 10- Modern Portfolio Theory - Modern Portfolio...

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Modern Portfolio Theory Risk Uncertainty about future cash flows Typically use variance or standard deviation of returns . Return Typically use expected return This is an ex-anti or forward looking return Contrast with a ex-post or backward looking return.
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Risk and Return
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Risk and Return Note: When we look only at expected return and standard deviation as our measures of return and risk we are implicitly assuming either: 1. Asset returns are normally distributed OR 1. Investors have quadratic utility functions – which means that investors only consider expected return and standard deviation when making investment decisions
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Are Asset Returns Normal? Approximately for portfolios of stocks if returns are measured over intervals of one month or more. However, it is not true for individual stocks or if returns are measured at high frequencies.
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Do Investors have quadratic utility functions? No!
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Lecture 10- Modern Portfolio Theory - Modern Portfolio...

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