6.short_sales_theory

# 6.short_sales_theory - University of California Los Angeles...

This preview shows pages 1–2. Sign up to view the full content.

University of California, Los Angeles Department of Statistics Statistics C183/C283 Instructor: Nicolas Christou The efficient frontier with short sales allowed An investor can often sell a security that he does not own. This process is called “short selling”. So far we have assumed that short sales are not allowed which means x i 0 , i = 1 , · · · , n . When short sales are allowed some of the x i can be negative but as before always n i =1 x i = 1. With short sales allowed the investor can achieved larger expected returns but as we will see below this large increase in the expected return is associated with a very large increase in risk. Consider the following example with 2 stocks. A B ¯ R 0.14 0.08 σ 0.06 0.03 In addition ρ AB = 0 . 5. If short sales are not allowed the largest expected return the investor can have is 14% (invest all his wealth in stock A ). However, with short sales allowed higher expected returns can be achieved by short selling stock B (borrow B and sell it). The proceeds are used to buy more shares of stock A . For example, suppose the investor initially has \$100 to invest. The investor can short \$1000 worth of stock B and invest now \$1100 in stock A .

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern