...Modern Portfolio Theory in the Modern Economy: MPT During the Credit Crisis 0f 2008 Abstract There are various theories of risk and return as it pertains to measuring and predicting investment return in a portfolio- one of the oldest and most prominent being Modern Portfolio Theory .An example of a hypothetical portfolio utilizing the principles of MPT invested during the credit crisis of late 2008/early 2009 will be utilized in part. In direct application, does Modern Portfolio theory hold strong during a major financial crisis? Past research will be compared to present the mechanics and applications of MPT order to answer the questions poised and to create hypothetical portfolios based on past fund performance during the time period of 2007 -2010. It is expected that a portfolio using MPT would not have performed significantly better than any other less diversified investment. Contents Introduction……………………………………..........................................................................4-7 Credit Crisis Thesis Statement Modern Portfolio Defined Prior Research Prediction Method…………………………………………………….........................................................8-9 Parameters/ Source of Portfolios Results……………………………………………………......................................................10-19 A. Application/ graphs Conclusion…………………………………………...............………………………............19-20 Restatement of Thesis Discussion of Results Limitations Recommendation References……………………………………………………………………...
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...earlier work, introduced the theory of modern portfolio and diversification. Along with Markowitz (1952), he began the theory of the model in 1956 when he was trying to find a dissertation topic. He built on Markowitz’s suggestions and set out his developed theory in his book “Portfolio Theory and Capital Markets.” (1970). This essay will try to outline the Capital Asset Pricing Model, explain the theory behind the model and outlay its uses. This will be done by using legal texts, journals and other resources. It is never possible to get rid of all the risk when investing and the actual return on an investment may differ from what the investor expects. For that reason investors always look for a rate of return that will repay them for their risk taking. The Capital Asset Pricing Model (CAPM) is a model that relates risk and return, helping investors calculate the risk of the investment and the return on the investment that should be expected. Haim Levy and Thierry Post (2005, p883) define the model as an “equilibrium asset-pricing model that predicts a linear relationship between expected return and beta.” It would be assumed that if an investor has decided to invest in a number of companies, the risk of the portfolio would be the average risk of each of the investments. However, the portfolio risk is in fact smaller therefore; the overall risk can be reduced by diversifying the investments in a portfolio. This is done by investing in a variety of investments such as stocks and bonds...
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...Economics Financial Theory Ben McClure Contact | Author Bio Advertisement No matter how much we diversify our investments, it's impossible to get rid of all the risk. As investors, we deserve a rate of return that compensates us for taking on risk. The capital asset pricing model (CAPM) helps us to calculate investment risk and what return on investment we should expect. Here we look at the formula behind the model, the evidence for and against the accuracy of CAPM, and what CAPM means to the average investor. Birth of a Model The capital asset pricing model was the work of financial economist (and, later, Nobel laureate in economics) William Sharpe, set out in his 1970 book "Portfolio Theory And Capital Markets." His model starts with the idea that individual investment contains two types of risk: Systematic Risk - These are market risks that cannot be diversified away. Interest rates, recessions and wars are examples of systematic risks. Unsystematic Risk - Also known as "specific risk," this risk is specific to individual stocks and can be diversified away as the investor increases the number of stocks in his or her portfolio. In more technical terms, it represents the component of a stock's return that is not correlated with general market moves. Modern portfolio theory shows that specific risk can be removed through diversification. The trouble is that diversification still doesn't solve the problem of systematic risk; even a portfolio of all the shares...
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...PORTFOLIO PERFORMANCE EVALUATION- LITERATURE REVIEW Deepa Chandrashekar Table of Contents 1. Introduction........................................................................................................................................... 2 2. Portfolio Returns Calculation................................................................................................................ 4 2.1. 2.2. Value weighted rate of return........................................................................................................ 6 2.3. 3. Time weighted rate of return......................................................................................................... 5 Internal rate of return .................................................................................................................... 6 Literature Review.................................................................................................................................. 7 3.1. Sharpe ratio ................................................................................................................................... 9 3.2. Sortino ratio ................................................................................................................................10 3.3. Treynor ratio ...............................................................................................................................12 3.4. Jensen ratio...
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...1. INTRODUCTION 1.1. INDUSTRY ALLOCATION The assets, combined in this portfolio, have been chosen from three different industries – banking, retail and drug manufacturing industry. Each industry has its own characteristics and distinguishes from one another, for the purpose of creating a diversified portfolio. Factors, affecting the banking sector and Barclays Bank (the chosen asset) are related to the current economic crisis, interest rates and the policy led by the government (either encouraging spending or saving). On the other hand the retail industry, represented by Marks and Spencer in this portfolio, is affected by the current economic climate in term of disposable and discretionary income. The final industry, drug manufacturing, which is most dependent on research and development, which incur high input costs and require a lot of testing (meaning the business process is time-consuming), is represented by GlaxoSmithKline. The three industries can be affected by completely different factors in nature. 1.2. PORTFOLIO CONSTRUCTION This portfolio was constructed by stocks, listed only on the London Stock Exchange (LSE), with no interaction with emerging markets. Although international diversification is not present, the unsystematic risk is lower due to the investment in already developed market (LSE), allowing enough liquidity and establishing fair price of the assets. The three companies (Barclays Bank, Marks and Spencer and GlaxoSmithKline) are all blue chips, with...
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...University Graduate School of Business, Stanford, California, USA INTRODUCTION* Following tradition, I deal here with the Capital Asset Pricing Model, a subject with which I have been associated for over 25 years, and which the Royal Swedish Academy of Sciences has cited in honoring me with the award of the Prize in Economic Sciences in Memory of Alfred Nobel. I first present the Capital Asset Pricing Model (hence, CAPM), incorpo1 rating not only my own contributions but also the outstanding work of Lintner (1965, 1969) and the contributions of Mossin (1966) and others. My goal is to do so succinctly yet in a manner designed to emphasize the economic content of the theory. Following this, I modify the model to reflect an extreme case of an institutional arrangement that can preclude investors from choosing fully optimal portfolios. In particular, I assume that investors are unable to take negative positions in assets. For this version of the model I draw heavily from papers by Glenn (1976), Levy (1978), Merton (1987) and Markowitz (1987, 1990). Finally, I discuss the stock index futures contract - a major financial innovation of worldwide importance that postdates the development of the CAPM. Such contracts can increase the efficiency of capital markets in many ways. In particular, they can bring actual markets closer to the idealized world assumed by the Capital Asset Pricing Model. THE CAPITAL ASSET PRICING MODEL The initial version of the CAPM, developed over 25 years ago, was extremely...
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...Beth A. Walker Balancing Risk and Return in a Customer Portfolio Marketing managers can increase shareholder value by structuring a customer portfolio to reduce the vulnerability and volatility of cash flows. This article demonstrates how financial portfolio theory provides an organizing framework for (1) diagnosing the variability in a customer portfolio, (2) assessing the complementarity/similarity of market segments, (3) exploring market segment weights in an optimized portfolio, and (4) isolating the reward on variability that individual customers or segments provide. Using a seven-year series of customer data from a large business-to-business firm, the authors demonstrate how market segments can be characterized in terms of risk and return. Next, they identify the firm’s efficient portfolio and test it against (1) its current portfolio and (2) a hypothetical profit maximization portfolio. Then, using forward- and back-testing, the authors show that the efficient portfolio has consistently lower variability than the existing customer mix and the profit maximization portfolio. The authors provide guidelines for incorporating a risk overlay into established customer management frameworks. The approach is especially well suited for business-to-business firms that serve market segments drawn from diverse sectors of the economy. Keywords: customer portfolio management, market-based assets, financial portfolio theory, return on marketing, market segmentation The advantage...
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... Table of Contents Table of Contents 1 1.0 Multifactor model 2 2.0 Arbitrage pricing theory (APT) 2 3.0 Multifactor Models (APT) and Testing 4 Reference 7 Multifactor model Estimation of returns on security and APT on International level demonstrating Factors Those are statistically significant 1.0 Multifactor model Pardalos (1997) defines multifactor model as a financial model which uses multiple factors during computation to explain a given market phenomena or at a given equilibrium market prices. The model is also useful in explaining both the individual and portfolio market securities. This is capable through comparison of two or more factors which are being analyzed to determine the relationship between the securities performance and the variables. Formula can be used to express the relationship Return on equity (Ri), Market return (Rm), factor search (F 1, 2…) 2.0 Arbitrage pricing theory (APT) The relationship between literature theories and the stock market behavior is the Asset Pricing model (Levy and Thierry 2005). Consigli and Wallace (2000) in their study, indicates that both are used in whenever securities are being given price and the individual assets risk are also being priced and can also be used in between portfolio to give a more insights of business activities and behavior hence helps in calculating related discounts security...
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...Judge the Risk by Portfolio When the investors put their money into the stock market, it means that they must take the risk of the stock market, because risk is one of the natural qualities of the stock market. One company easy to get a poor performance and its stocks will go down. Therefore, there will be no way to complete avoid risk, but judge it. In finance, risk is best judged in a portfolio context. Because the possibility that many companies gets serious performances, and their stock price go down at the same time is lower than for only one company. This essay will discuss that why the portfolio context is the best way to judge the risk in the finance market. The first part will introduce the basic theories for portfolios. The methods of measuring risks and value of the portfolio will be explained in the second part to demonstrate that why it is better select portfolios. The third part will give the example of family groupings on performance of portfolio selection in the Hong Kong stock market. The conclusion will be given at the end of the essay. Firstly, the theory of portfolio and the five suppositions of portfolio selection need to be explained before the following discussion of the value of portfolios. The article ‘Portfolio Selection’, which was issued on Journal of Finance in 1952 and the book ‘Portfolio Selection: Efficient Diversification of Investments’ which was published in 1959 was known as the opening if the modern portfolio theory. The author of these...
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...Portfolio Strategy Assignment Demetrie M. Howard University of Phoenix Introduction The organization I have chosen to plan a portfolio strategy for is O’Connor and Associates. This organization is my current employer and it will be a challenge to create one for them. The organization is a property tax firm, it assist clients with reducing the appraised value of their property, which in turn reduces the amount of property taxes due. The organization is diversifying; it is going into third party collections, judgment recovery, and mortgage loans. This firm has made substantial errors in the past therefore to understand the cause and effect of those errors we will attempt to model their market and business behaviour. This model is an effort to estimate the expected results of alternative strategies and processes. Consumer expectations and other variables as well as technology, the internet, telecommunications and globalization have accelerated the pace of change, and shortened product lifecycles has contributed to this strategic plan. Technology has augmented the capability to amass information and respond to change immediately and analytically. It is also important for corporations to achieve and maintain their competitive advantages. Cash Infusion The cash infusion allocated to enhance the company and to manage is $40 million dollars. Following is the description of portfolio strategy and a portfolio of assets in relation to the investment of $40 million...
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...Review on Modern Portfolio theory Historical development and current state of theory: Modern Portfolio theory is developed by Markowitz (1952, 1959). Portfolio problem has been formulated as an option of the variance and mean of an asset portfolio. If investors concern on the return distributions for a single period, the mean and variance portfolio theory need to be developed to find the optimum portfolio. Then the investors need to find out the mean and the variance of return for each asset in the portfolio for that single period. Markowitz also has proved the fundamental theorem of mean variance theory, which are holding variance constant, maximize the expected return, as well as holding constant the expected return minimize variance. Based on these principles and individual risk return preferences, investors could choose their preferred portfolio and form the optimum efficient frontier. Issues in estimating the key inputs for portfolio theory There are two different models are used, which are index models and covariance estimates. The single-index model was developed and popularized by Sharpe (1967). However, multi-index model was developed to better explain the theory. Multi-index models can be used to provide inputs for a portfolio optimization technique; it also can be used to understand the sensitivity of the portfolio to various economic influences. If we make additional assumption that Capital Asset Pricing Model (CAPM) holds and ignore insight of Fama...
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...The Portfolio Theory also known as Modern Portfolio Theory was first developed by Harry Markowitz. He had introduced the theory in his paper ‘Portfolio Selection’ which was published in the Journal of Finance in 1952. In 1990, he along with Merton Miller and William Sharpe won the Nobel Prize in Economic Sciences for the Theory. The theory suggests a hypothesis on the basis of which, expected return on a portfolio for a given amount of portfolio risk is attempted to be maximized or alternately the risk on a given level of expected return is attempted to be minimized. This is done so by choosing the quantities of various securities cautiously taking mainly into consideration the way in which the price of each security changes in comparison to that of every other security in the portfolio, rather than choosing securities individually. In other words, the theory uses mathematical models to construct an ideal portfolio for an investor that gives maximum return depending on his risk appetite by taking into consideration the relationship between risk and return. According to the theory, each security has its own risks and that a portfolio of diverse securities shall be of lower risk than a single security portfolio. Simply put, the theory emphasizes on the importance of diversifying to reduce risk. Early on, investors stressed on individually picking high yielding stocks to earn maximum profits. So if one particular industry was offering good returns; an investor would have landed...
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...FINANCE PORTFOLIO ANALYSIS FINAL WORK DESCRIPTIVE ANALYSIS AND APPLICATION OF THE PORTFOLIO THEORY Abstract The main objective of the work is to construct, through application of the Portfolio theory, an efficient frontier which represents a set of portfolios with optimum risk-return ratio for ten companies from Mexican IPC. The sample used in this work is composed of the most representative companies in this index. A descriptive analysis of the behavior of the stocks included in this study is carried out using the binomial risk-return, which significantly contributes in selecting the most suitable stocks to be included in the portfolio. The work is concluded with finding an optimal portfolio for a risk adverse investor. The main conclusions from study are the poor performance of the construction sector, which holds the lowest returns, the highest risk and negative performance ratios, and the usefulness of the theory of portfolios to get a set of portfolios with higher returns and lower risk than the general Mexican IPC index that represents the market. The importance of diversification of assets is also noted. Keywords: Portfolio theory, Efficient Frontier, Risk-Return, Minimum Variance, Portfolio Contents 1. Introduction 6 1.1 Introduction 6 1.2 Goals 7 1.3 Methodology 7 1.4 Structure 9 2. Theoretical Framework 11 2.1 Risk and Return 11 2.1.1 Portfolio’s Expected Return 12 2.1.2 Portfolio Risk (Standard Deviation) 13 2.2 Diversification...
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...Efficient portfolio & Stock market efficiency Prepared by: Ahmed Mohamed Ahmed Zaki Nofal Submitted to: Dr.Tarek el Domiaty Modern portfolio theory Modern portfolio theory (MPT) is a theory of finance which attempts to maximize portfolio expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return, by carefully choosing the proportions of various assets. Although MPT is widely used in practice in the financial industry and several of its creators won a Nobel memorial prize[1] for the theory, in recent years the basic assumptions of MPT have been widely challenged by fields such as behavioral economics. MPT is a mathematical formulation of the concept of diversification in investing, with the aim of selecting a collection of investment assets that has collectively lower risk than any individual asset. That this is possible can be seen intuitively because different types of assets often change in value in opposite ways. For example, to the extent prices in the stock market move differently from prices in the bond market, a collection of both types of assets can in theory face lower overall risk than either individually. But diversification lowers risk even if assets' returns are not negatively correlated—indeed, even if they are positively correlated More technically, MPT models an asset's return as a normally distributed function (or more generally as an elliptically distributed random...
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...Introduction Investment In finance, investment is putting money into an asset with the expectation of capital appreciation, dividends, and/or interest earnings. This may or may not be backed by research and analysis. Most or all forms of investment involve some form of risk, such as investment in equities, property, and even fixed interest securities which are subject, among other things, to inflation risk. It is indispensable for project investors to identify and manage the risks related to the investment. Investment Management Investment management is the professional asset management of various securities (shares, bonds and other securities) and other assets (e.g., real estate) in order to meet specified investment goals for the benefit of the investors. Investors may be institutions (insurance companies, pension funds, corporations, charities, educational establishments etc.) or private investors (both directly via investment contracts and more commonly via collective investment schemes e.g. mutual funds or exchange-traded funds). The term asset management is often used to refer to the investment management of collective investments, while the more generic fund management may refer to all forms of institutional investment as well as investment management for private investors. Investment managers who specialize in advisory or discretionary management on behalf of (normally wealthy) private investors may often refer to their services as money management or portfolio management...
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