Financial Market Theory Thursday, October 2, 2018 Professor Edwin T Burton
Harry Markowitz As a graduate student in Economics at University of Chicago in the 1950s, Harry wanted to know how to optimally construct a portfolio of stocks Harry’s analysis has come to be known as “Mean-Variance” analysis. October 2, 2018
Harry Assumes: No two assets are perfectly correlated: There is no risk free asset: σi > 0 for every i (asset i) No two assets are perfectly correlated: σx,y < 1 for every x, y (assets x and y)
Harry’s Main Conclusion: Portfolio Choice Mean Green Curve is Markowitz’s “Efficient Portfolio” set More risk Less risk σ σ October 2, 2018
Tobin’s Result If there is a riskless asset It changes the feasible set All optimum portfolios contain The risk free asset and/or The portfolio E …….in some combination…. The Mutual Fund Theorem James Tobin, Prof of Economics Yale University Winner of Nobel Prize in Economics 1981 October 2, 2018
The risk free asset The one with the highest mean Mean Standard Deviation October 2, 2018
Combine with Risky Assets Mean ? Risky Assets Risk Free Asset Standard Deviation October 2, 2018
If 1 is zero P2 = (2)222 (2)2 P = If one of the standard deviations is equal to zero, e.g. 1 then P2 = (2)222 (2)2 P = Which means that: October 2, 2018
Combine with Risky Assets Mean Risk Free Asset Standard Deviation
Combine with Risky Assets Mean The New Feasible Set E Always combines the risk free asset With a specific asset (portfolio) E Risk Free Asset Standard Deviation October 2, 2018
Tobin’s Result Mean Use of Leverage E Risk Free Asset Standard Deviation
Tobin’s Result Mean Use of Leverage E Risk Free Asset Standard Deviation October 2, 2018
October 2, 2018