Download
1 / 29
290 likes | 304 Views
Explore the principles of Modern Portfolio Theory, portfolio risk, and efficient frontier. Understand the importance of diversification and making informed forecasts for successful asset allocation. Delve into asset diversification and the theoretical correctness of portfolio management. Discover key rules and principles to optimize excess return space.
E N D
Asset/Liability; The Evolution Goes On Presented by: D Sykes Wilford SPS HOLDINGS Designed for AXA Belgium SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On MODERN PORTFOLIO THEORY The Risk of a portfolio can be lower than the risk of any of its components CONDITION: A sufficient number of weakly correlated assets in the portfolio SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Portfolio Risk 2 assets/equal weights case: Var (1/2A+1/2B)=1/4Var(A)+1/4Var(B)+2.1/4.Cov(A,B) where Cov(A,B)=Corr(A,B)ÖVar(A) ÖVar(B) or if Corr(A,B)<1, and Var(A)=Var(B) Var(1/2A+1/2B)<Var(A) and Var(1/2A+1/2B)<Var(B) Investing in both assets is less risky than investing in either one of them separately! SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On The Theoretical Efficient Frontier Return ? Risk SPS Holdings wsykes@laudisi.com
Risk ý Locally Diversifiable ý Globally Diversifiable Non Diversifiable Risk Number of Assets Asset/Liability; The Evolution Goes On Modern Portfolio Theory SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Bankers Trust Company SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On But What Does This Practically Mean? or A Step By Step Approach to Theoretical Correctness SPS Holdings wsykes@laudisi.com
Diversify Asset/Liability; The Evolution Goes On Back to Basics Bankers Trust Company SPS Holdings wsykes@laudisi.com
Diversify Diversify Diversify Asset/Liability; The Evolution Goes On Back to Basics SPS Holdings wsykes@laudisi.com
Diversify Diversify Diversify Asset/Liability; The Evolution Goes On Back to Basics Nobel Prize Nobel Prize Nobel Prize SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Back to Basics Portfolio Theory is about Diversification • Everywhere • All the time • In a friction free world SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Portfolio Theory Exists Because No One Is Prescient ! SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Remember No One Is Prescient • If so then you do not need a Portfolio • Since you are going to be wrong; how wrong? Big Wrong Little Wrong SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On We need a guess about the future: A Forecast of Expected Returns E[R] SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Back to Basics s = Standard Deviation of E[R] r= Correlation of the errors in those expected returns SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Back to Basics sis NOT Actual Variance ris NOT Actual Correlation SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Back to Basics The r needed for portfolio allocation need not reflect what actually happens ---- Indeed it should not if our forecaster of E[R] is not perfect SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Being Theoretically Correct ! "No PC Allowed" Science is more important than what "sounds" right! SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Back to Basics - Rule 1 What Expected Return? Not Total Return but Excess Return E[R] = Total Return - Risk Free Rate SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Back to Basics - Rule 2 Thuss and rare relative to the expected Excess Return But s Total Return @s Excess Return SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Back to Basics - Examples Classic Example Total Return Risk Total Return Ratios Excess Returns Example Excess Return Risk Excess Return Ratios Equities 12 12 1 Equities 6 12 .5 Bonds 8 8 1 Bonds 2 8 .25 Cash 6 0 N/A Cash 0 0 N/A SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Back to Basics - Rule 2: An Example Currency of Denomination • Total Return Portfolio • Excess Return Portfolio SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Back to Basics - Rule 3 Optimization in Excess Return space • Excess Returns • E[R] • s of E[R's] • r of Errors in those E[R's] No Constraints SPS Holdings wsykes@laudisi.com
Cumulative Excess Return DSUR 0.60 0.50 0.40 0.30 DOLS 0.20 0.10 0.00 CASH -0.10 8612 8706 8712 8806 8812 8906 8912 9006 9012 9106 9112 9206 9212 9306 Asset/Liability; The Evolution Goes On DSUR and DOLS Portfolio Performance SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On Back to Basics Consistency is the Key • E[R] • Variance of E[R] • Correlation of E[R] SPS Holdings wsykes@laudisi.com
Asset/Liability; The Evolution Goes On RULES: • Excess Return Space • s and r relate to the E[R's] • No Constraints SPS Holdings wsykes@laudisi.com
