1. Financial Market Theory
Thursday, October 2, 2018
Professor Edwin T Burton

2. 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

3. 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)

4. Harry’s Main Conclusion: Portfolio Choice
Mean
Green Curve is Markowitz’s “Efficient Portfolio” set
More risk
Less risk σ σ
October 2, 2018

5. 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

6. The risk free asset The one with the highest mean Mean
Standard Deviation
October 2, 2018

7. Combine with Risky Assets
Mean ?
Risky Assets
Risk Free
Asset
Standard Deviation
October 2, 2018

8. If 1 is zero  P2 = (2)222 (2)2  P =
If one of the standard deviations is equal to zero, e.g. 1 then
 P2 =
(2)222
(2)2
 P =
Which means that:
October 2, 2018

9. Combine with Risky Assets
Mean
Risk Free
Asset
Standard Deviation

10. 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

11. Tobin’s Result Mean Use of Leverage E Risk Free Asset
Standard Deviation

12. Tobin’s Result Mean Use of Leverage E Risk Free Asset
Standard Deviation
October 2, 2018

13. October 2, 2018