For an average portfolio, managers are looking at 8% return.
Markowitz portfolio theory (MPT)
Assumptions : efficient investors , risk free rate, homogenous expectation, ,fractional holding, ignore
inflation and taxes, and fair pricing( market efficiencies)
MPT to capital markets theory (CMT)
- Risk free asset has zero standard deviation, variance, correlation and covariance ( with other
- Note that the tangent CML to the Markowitz frontier is the best possible choice giving you a
balanced risk return.
Risk diversification and the Market portfolio
Total risk = systematic risk + unsystematic risk ( which can be eliminated via diversification)
The security market line (SML)
Beta is the measure of risk in this case
Where SML shows a balance between the risk and return for a particular asset
- Below the SML is overpriced
- Above the SML is underpriced
The capital asset pricing model (CAPM)
Underpriced assets would be purchased by arbitrageur and therefore move the price higher so as to
bring them to the SML and bring about efficiency and vice versa
- Problems with CAPM:
Beta is not stable and has various methods for calculation.
There is no “true” market portfolio : In Canada we use TSX as the proxy which is