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that any efﬁcient portfolio can be constructed as a
combination of the fund P and the risk-free asset.
The Separation Theorem: a.k.a. “lighten the work of a mutual fund manager"!
K.S. Tan/Actsc 372 F11 Modern Portfolio Theory & CAPM – p. 40 The Separation Theorem
Portfolio choice decision can be separated into two stages:
I: Determining optimal risky portfolio (only risky assets)
this portfolio is identical for all investors that share
the same input estimates (expected returns and
variances, and covariances;)
· i.e. homogeneous expectations
independent of investors’ risk aversion
One fund theorem
II: Choice of optimal mix of the risky portfolio and the
risk-free asset (optimal overall portfolio)
investor’s overall portfolio is a linear combination of
the optimal risky portfolio and the risk-free asset
this depends on investor’s risk aversion
here investor is the decision maker
K.S. Tan/Actsc 372 F11 Modern Portfolio Theory & CAPM – p. 41 An Illustration of The Separation Theorem
Assume the economy consists of 2 risky assets (RIM &
SLF) and a risk-free asset
Suppose the c...
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This note was uploaded on 01/04/2012 for the course ACTSC 372 taught by Professor Maryhardy during the Fall '09 term at Waterloo.
- Fall '09