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2 Portfolio theory

Harry Markowitz

Returns follow normal distribution

- standard diviation is the risk

- mean is positive

Diversification can reduce risk.

Invest in not correlated securities

Harry Markowitz

Diversification of portfolio

A free lunch on risk

Right assets at the right weighting - considring risk and correlation

" H.C. Andersens Konen med æggene

Correlation of stocks

Risk

The more diverse portfolio - the less unsystematic risk

Risk can be measured by volatility (=Standard Deviation of the stock return over time)

Systematic risk

Risks that affect the entire market

Unavoidable

Examples

Black Monday

(Oct. 19th 1987)

9/11 2001

BETA

A measure of systematic risk of a security/portfolio compared to market risk.

BETA

Synonyms

Market-level risk

Market risk

Non-diversifyable risk

Synonyms

Unsystemic risk

specific to individual companies

specific to individual industry

can be avoided by diversification

Synonyms

Diversifyable risk

Asset-specific risk

Firm-specific risk

Idiosycratic risk

Modern Portfolio Theory

In fact the mathematical interpretation of how diversifacation is supposed to work

Modern Portfolio Theory

Dominance principle

Among investments with the same rate of return, the one with the least risk is most desirable.

Dominance principle

Efficient portfolio frontier

Portfolio with the highest level of return for a given risk.

More Return/Risk effective than any stock.

Note:

Historically based

500 S&P index

Close to ideal portfolio (market portfolie)

500-ish stocks of large-cap companies

Efficient portfolio frontier graph

Market portfolios

Tangent-touch-point-portfolio.

Market portfolios

Mutual fund seperation theory ?

By James Tobin:

Mutual fund seperation theory ?

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