review_part2

review_part2 - The Portfolio Allocation Problem The first...

Info iconThis preview shows pages 1–7. Sign up to view the full content.

View Full Document Right Arrow Icon
The Portfolio Allocation Problem The first step in this process is to find the expected returns , standard deviations , and correlations of all assets under consideration. Next, we combine the risky assets available to us in a portfolio. This is accomplished by finding the portfolio of risky assets, among all possible portfolios, that has the highest Sharpe ratio. This is the optimal portfolio of risky assets, also called the tangency portfolio. Finally, we combine the tangency portfolio with the risk-free asset. This is accomplished by taking the risk-aversion of the investor into account. The more risk-averse the investor is, the less he will allocate to the tangency portfolio. Where do the Correlations Come From?
Background image of page 1

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

View Full Document Right Arrow Icon
Index Model Example : If you want to invest in 100 stocks, you need to compute 4950 different correlations. There are lots of parameters to estimate with error. A useful solution : Use an index model to estimate the correlations.
Background image of page 2
The index model implies that: where
Background image of page 3

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

View Full Document Right Arrow Icon
The index model regression for small stocks yields this output: The index model regression for large stocks yields this output:
Background image of page 4
What is the correlation between small and large stocks, according to the index model?
Background image of page 5

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

View Full Document Right Arrow Icon
Where do the Expected Returns Come From? CAPM
Background image of page 6
Image of page 7
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

Page1 / 12

review_part2 - The Portfolio Allocation Problem The first...

This preview shows document pages 1 - 7. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online