Modern Portfolio Theory Essay

So according to the Efficient Market Theory it is impossible for any investor to “beat the market” that is earn more profit or get more return than what the market is actually offering. Therefore the investor can only earn greater profits on his investment if the investment portfolio includes a high proportion of risky investments that is those with higher standard deviations and betas but with a good capability of yielding high returns as well (Stephens, C.R., 2010).

Advisors and investors would do well to pay as much attention to the expected volatility of any portfolio or investment as they do to anticipated returns. Moreover, all things being equal, a new investment should only be added to a portfolio when it either reduces the expected risk for a targeted level of returns, or when it boosts expected portfolio returns without adding additional risk, as measured by the expected standard deviation of those returns. Lesson 2: Don’t assume bonds or international stocks offer adequate portfolio diversification. As the world’s financial markets become more closely correlated, bonds and foreign stocks may not provide adequate portfolio diversification. Instead, advisors may want to recommend that suitable investors add modest exposure to nontraditional investments such as hedge funds, private equity and real assets. Such exposure may bolster portfolio returns, while reducing overall risk, depending on how it is structured. Lesson 3: Be disciplined in adhering to asset allocation targets. The long-term benefits of portfolio diversification will only be realized if investors are disciplined in adhering to asset allocation guidelines. For this reason, it is recommended that advisors regularly revisit portfolio allocations and rebalance

“The Benefits of diversification are clear. Portfolio theory has played a crucial role in explaining the relationship between risk and return where more than one investment is held. It also enables us to identify optimal and efficient portfolios.”

Buffett challenges the conventional wisdom regarding diversification. He argues that holding a few good stocks is far more important than spreading funds across a broad number of stocks. It is a fact that investors have been so oversold on diversification that the fear of having too many eggs in one basket has caused them to invest very little into companies about which they thoroughly know and far too much into others about which they know nothing at all. It is a dangerous thing to do as buying a company without sufficient knowledge may turn out to be even more dangerous than having adequate diversification.

Chapter seven: What does the efficient market theory have to do with Financial markets? Discuss the positives and negatives of the theory. Why do Wall-Street types not like it? Explain the coin flipping experiment, as it relates to investment diversification.

Chapter seven: What does the efficient market theory have to do with Financial markets? Discuss the positives and negatives of the theory. Why do Wall-Street types not like it? Explain the coin flipping experiment, as it relates to investment diversification.

Harry Markowitz 1991, developed a theory of “Portfolio choice”, that allows the investors to examine the risk as per the expected returns. In modern World, this theory is known as Modern portfolio theory (MPT). It attempts to attain the best portfolio expected return for a predefined portfolio risk, or to minimise the risk for the predefined expected returns, by a careful choice of assets. Though it’s a widely used theory, still has been challenged widely. The critics question the feasibility of theory as a strategy for

I strongly advocate tactical asset allocation process and diversification over several different income and growth strategies. I believe that risk management and protection of investor's endowment are major objectives. In my portfolio, stocks may occupy a large portion and the

The idea behind diversification is to invest in a large number of assets so that a loss in any particular investment is minimized by gains

In order to find the optimal portfolio allocation, the group needs to find the portfolio structured with lowest risk under a given return. This can be achieved by applying Mean-Variance Theory and Markowitz model find the efficient frontier, which yields the most optimal portfolio under given returns. It can be expressed in mathematical terms and solved by quadratic programming. [Appendix A]

“…anointing winners and losers on the basis of 12 months’ worth of performance is silly in the context of portfolios that are being managed with incredibly long time horizons.” — David F. Swensen, Chief Investment Officer, Yale University1

There is a sense of complexity today that has led many to believe the individual investor has little chance of competing with professional brokers and investment firms. However, Malkiel states this is a major misconception as he explains in his book “A Random Walk Down Wall Street”. What does a random walk mean? The random walk means in terms of the stock market that, “short term changes in stock prices cannot be predicted”. So how does a rational investor determine which stocks to purchase to maximize returns? Chapter 1 begins by defining and determining the difference in investing and speculating. Investing defined by Malkiel is the method of “purchasing assets to gain profit in the form of reasonably

The success of the model is attributed to Yale’s ability to combine both quantitative analysis (mean-variance analysis) with market judgments to structure its portfolio. In addition, Yale also uses statistical analysis to actively test their models with factors affecting the market, therefore understanding the sensitivity of their portfolio in response to various market changes. Yale also follows and forecasts the cash flow of private equity and real assets in its portfolio to decide the need for hedging.

The objective of studying this case is to understand the concepts of diversification and the efficient frontier by analyzing Harvard Management Company’s application of portfolio theory for managing the endowment of Harvard University. Please read the case carefully and be prepared to discuss the following questions in class on Monday, October 11.

As a result, many different factors have been tested across different markets. Historically, most studies have relied on general economic theories or empirical observations in selecting Factors. Benaković and Posedel (2010) emphasize Interest rates, oil prices, and industrial production. Chen, Roll and Ross (1986) use industrial production growth, inflation, bonds spread, NYSE stock market returns, oil prices, interest term structure, and consumption to decompose returns of a portfolio with general securities. Bodurtha, Cho and Senbet (1989) even uses international factors. Most of literatures have focused on applying different factors with a portfolio of many securities, as it is widely known that idiosyncratic risks diversifies away as the number of