1 / 19

Economics 434 Theory of Financial Markets

Economics 434 Theory of Financial Markets. Professor Edwin T Burton Economics Department The University of Virginia. Modern Portfolio Theory . Three Significant Steps to MPT Harry Markowitz Mean Variance Analysis The Concept of an “Efficient Portfolio” James Tobin

osborn
Download Presentation

Economics 434 Theory of Financial Markets

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Economics 434Theory of Financial Markets Professor Edwin T Burton Economics Department The University of Virginia

  2. Modern Portfolio Theory • Three Significant Steps to MPT • Harry Markowitz • Mean Variance Analysis • The Concept of an “Efficient Portfolio” • James Tobin • What Happens When You Add a “Risk Free Asset” to Harry’s story • Bill Sharpe (Treynor Lintner, Mossin, etal) • Put Tobin’s Result in Equilbrium • The Rise of Beta • The Insignificance of “own variance”

  3. 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

  4. The risk free asset Mean The one with the highest mean Standard Deviation

  5. Combine with Risky Assets Mean ? Risky Assets Risk Free Asset Standard Deviation

  6. Recall the definition of the variance of a Portfoliowith two assets  P2 =  (P - P)2 n = {1(X1- 1) + 2(X2 - 2)}2 n

  7. Variance with 2 Assets - Continued = (1)212 + (2)222 + 2121,2 Recall the definition of the correlation coefficient: 1,2 1,2 12 = (1)212 + (2)222 + 2121,212

  8. If 1 is zero  P2= (1)212 + (2)222 + 2121,212 If one of the standard deviations is equal to zero, e.g. 1 then  P2 = (2)222 (2)2  P = Which means that:

  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

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

  12. Capital Asset Pricing Model • Makes all the same assumptions as Tobin model • But Tobin’s model is about “one person” • CAPM puts Tobin’s model in equilibrium, by assuming that everyone faces the same portfolio choice problem as in Tobin’s problem • Only difference between people in CAPM is that each has their own preferences (utility function)

  13. CAPM – two conclusions • M – the “efficient” basket • The pricing rule based upon “beta”

  14. First Conclusion Mean M What is M ? Answer: contains all “positively” priced assets, weighted by their “market” values. Rf STDD

  15. Second Conclusion: After all the math is over For every asset, i i = Rf + i [M – Rf] Cov (i, M)  I , M Where i =  2M Var (M) This is often called the “Capital Asset Pricing Model”

  16. Capital Market Line Mean M What is M ? Answer: contains all “positively” priced assets, weighted by their “market” values. Rf STDD

  17. Security Market Line i = Rf + i [M – Rf] Mean i M Rf Security Market Line Beta 1

  18. Random Questions • What is the beta of the market? • Why not just buy one stock with the beta of the market? • Can betas be negative? What does it mean? • Is this model testable?

  19. The End

More Related