Investments, Thursday April 2, 2009 Need-to-know: Hand-In #1 has been posted. Deadline April 17. There are no lectures tomorrow. Scientific contents: More on the results of Case 1 where Hue and Mario trade ’till equilibrium. The rest of Sharpe Ch. 2 ”Nitty-gritty details” of utility maximization and trading. Sharpe Ch. 3 up to ~3.8.

How? Sharpe’s Case 1 Excel-file ”Old school” i.e. whiteboard My Case1ByHand Excel-file supported w/ a note on Section 3.7

In Equilibrium in Case 1 Hue and Marie completely diversify non-market risk away. (In this case, ”non-market risk” has a clear-cut interpretation: whether the fish go North or South.) Market risk cannot be diversifed away. The less risk-averse Mario bears more of that. As compensation, his expected returns are higher (as we shall see).

Gains from Trade ”Ex-ante” (i.e. beforehand) trading makes both Hue and Mario better off. ”Ex-post”: Yeah, well, we don’t know exactly what happens. Sharpe says this in Section 2.9.3. Sounds perfectly reasonable. In Hand-In #1 you get to work on how (and how not) to quantify it.

Concepts and Quantitative Ceveats The market portfolio: The total of risky assets. In Case 1 the portfolio w/ 10 shares of MFC and 10 shares of HFC. (Some sources define portfolios via the security weights, not the #securities.) Return: Sharpe’s ”returns” are ”gross rates”, i.e. price(time 1)/price (time 0). (Some sources use ”net rates” or ”profit and loss”.)