Portfolio Managements

Summaries

Mean-variance Analysis (Capital Market Theory) (Markowitz)

-          investors are risk-averse

-          investors make decision based solely on mean, variance, co-variance

-          these parameters are known to the investors

-          no tax or transaction costs

Mean E(Rp) = w1*E(P1) + w2 * E(P2)

Variance = w1^2*sigma_P1^2 + w2^2*sigma_P2^2 + 2*w1*w2*Covariance

Correlation = Covariance / (sigma_P1*sigma_P2)

This is used to plot the expected return – standard deviation curve (return risk trade-off curve)

Minimum Variance Portfolio: minimum variance for a given expected return

Minimum Variance Frontier: graph of combination of all minimum variance portfolio *** Not the same as return risk trade-off curve though they have similar shape, a subset of return risk trade-off curve because there can be a many curves?

Global minimum variance portfolio: smallest variance in the frontier

Efficient frontier – the concave part of the minimum variance frontier. (max return for given risk AND min risk for given return)