RSM332H1 Lecture Notes - Lecture 8: Market Portfolio, Market Capitalization, Idiosyncrasy
Document Summary
Consider how adding asset contributes to portfolio and changes portfolio. Utility depends only on mean and variance of returns. Returns are jointly normally distributed or people have quadratic utility. Investors plan for only for one identical holding period. Investors can borrow and lend without limit at risk-free rate. Is a value weighted portfolio of all risky assets. Price of one share times total number of shares. Market value of market portfolio = n n=1pnsn wn = pnsn/ n n=1pnsn. Tangent portfolio must have all assets to have optimal return and risk. If asset is not in tangent portfolio, demand will be lower. Price will go down because of disequilibrium between supply and demand. Lower price increases return, which increases demand until equilibrium. Reward per unit of risk must be same for all assets. E(ri) - rf / cov(ri, rtp) = e(rj) - rf / cov(rj, rtp) Rearrange buck for bang ratio for market portfolio and risky asset i.
