SU UGBA 133 LECTURE 12 PORT[1]. THEORY 3

SU UGBA 133 LECTURE 12 PORT[1]. THEORY 3 - BA 133, LECTURE...

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BA 133, LECTURE TWELVE, PORTFOLIO THEORY AND THE CAPITAL ASSET PRICING MODEL, CONTINUED. Before we proceed, I wish to spend a bit more time on international diversification, as shown in Figure 8.13 on page 233, which documents the significance of global diver- sification as well as the impact of short selling on the efficient frontier. Note also that the country coordinates are unstable, difficult to estimate using past data. The example of the Canadian equity market being dominated by other markets is not always the case. No good explanation, but one possible… “home bias.” There almost certainly is less diversification from international diversification than was possible when the country statistics were compiled for Figure 8.13. Why? Two good explanations: 1. Economic linkages between countries are greater now due to the global economy. 2. We may be able to anticipate economic trends in the other countries, but their stock prices appear to respond more swiftly than in previous years, so bargains dis- appear more rapidly. Are the best performances now coming from unanticipated developments? Probably. * * * * * * * * * * * * * Appendix 8.A is a review of the material you saw in BA 103, but it is so important that I want you to see it again. It is the explanation of how risk is reduced by the in- teractions of stock price movements simulataneously. Quite simply, as n, the number of stocks in your portfolio increases, it is the covari- ances that proportionately explain INCREASINGLY MORE of the risk of your port- folio, and the variances (or standard deviations) become less and less significant. Please refer to equation 8.10 in section 8.4 (this equation and equation 8.9 and figure 8.10 on pages 226-227 are all that I require you to understand in Section 8.4). Much of the remainder of 8.4 is advanced, tedious or both. Notice how much greater is the efficient frontier when short selling is permitted.
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This note was uploaded on 12/06/2011 for the course UGBA 133 taught by Professor Distad during the Summer '08 term at University of California, Berkeley.

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SU UGBA 133 LECTURE 12 PORT[1]. THEORY 3 - BA 133, LECTURE...

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