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Outline: Portfolio Selection With Two Risky Securities
Outline: Portfolio Selection With Two Risky Securities
Outline
Portfolio: expected return and SD Diversification Investment opportunity set Investor preference: risk-return tradeoff Optimal portfolio choice with 2 risky assets
E( Rp ) = i E ( Ri )
With 2 securities, the portfolio variance is:
i =1
2 p
2 = 12 12 + 2 22 + 2 1 2 12 1 2
2 p
3
and with correlation 27%. If an investor holds 60% in the US and 40% in JP what is the mean and volatility of the portfolio? volatility is another word for standard deviation
Prof. Lasse H. Pedersen 4
w 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
mean 0.150 0.149 0.147 0.146 0.144 0.143 0.142 0.140 0.139 0.137 0.136
volatility 0.230 0.212 0.195 0.179 0.166 0.155 0.147 0.143 0.143 0.146 0.154
Portfolio Terminology
The investment opportunity set consists of all available risk-return combinations. An efficient portfolio is a portfolio that has the highest possible expected return for a given standard deviation The efficient frontier is the set of efficient portfolios. It is the upper portion of the minimum variance frontier starting at the minimum variance portfolio. The minimum variance portfolio (mvp) is the portfolios that provides the lowest variance (standard deviation) among all possible portfolios of risky assets.
Portfolio Terminology
Mean-s tandard deviation frontier for US and Japan 0.18 0.17 0.16 0.15 Er 0.14 US 0.13 0.12 0.11 0.1 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4
JP
10
11