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Fin2: Sharpe Wed' April 22, 2009

Fin2: Sharpe Wed' April 22, 2009. Practical: Tutorials Wed's 10-12 in Aud. 7. (Effective now.) APSIM experience? Scientific contents: More on the results of Case 1 and on Sharpe's concepts (eq’, market pf/risk), returns and risk premia.The rest of Sharpe Ch. 2.

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Fin2: Sharpe Wed' April 22, 2009

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  1. Fin2: Sharpe Wed' April 22, 2009 Practical: • Tutorials Wed's 10-12 in Aud. 7. (Effective now.) • APSIM experience? Scientific contents: • More on the results of Case 1 and on Sharpe's concepts (eq’, market pf/risk), returns and risk premia.The rest of Sharpe Ch. 2.

  2. Expected utility maximization and ”nitty grutty details” of trading. Sharpe Ch. 3 up to ~3.8. Useful for Hand-In #1. How? • Sharpe’s Case 1 Excel-file • ”Old school” i.e. blackboard • My Case1ByHand Excel-file supported w/ a note on Section 3.7

  3. Sharpe’s Chapter 2 (and onwards) Market Risk-Reward Theorem (MRRT): Only market risk is rewarded with a higher expected return. You are not rewarded for taking risk that could be diversified away. A very sobering principle.

  4. If you think ”market risk” is vague, that ”that’s not how ’theorem’ works”: fair enough, but hang on … CAPM is one case where MRRT holds. (Here, the expected return relation is linear; it needn’t be.) MRRT holds in Case 1.

  5. 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).

  6. Equilibrium APSIM finds portfolios and prices such that supply (fixed) equals demand (optimally determined). We may see it just as a numerical solution method, rather than the ”rounds of trading”-explanation.

  7. We can verify that an output is an equilbrium. But is it unique? I don’t know. But can argue that ”it’s the one is achieved trough trading so it’s the relevant one.” But then: Is convergence guaranteed? Does the trading mechanism matter? (So it would seem.)

  8. 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 this week's tuturials you (or Cathrine) get to work on how (and how not) to quantify it.

  9. 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”.)

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