A.02.BKM Ch 07

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A.02.BKM Ch 07
2012-05-07 13:44:34
optimal risky portfolio

Optimal Risky Portfolios
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  1. Diversification & pf risk
    • Mkt / systematic: can not be diversified away
    • Unique / firm-specific / nonsys: can be eliminated via diversification (as long as Cor < 1)
  2. Pf of 2 risky assets

  3. Pf opportunity set
    Graph of all possible combinations of risky assets
  4. Optimal risky pf
    Avail pf that has highest Sharpe ratio. Tangent to CAL.
  5. Separation Principle
    • Selection of opt risky pf independent of A
    • A influences mix btwn opt risky pf & rf
  6. Min-var frontier
    • All pf that have lowest var for each level of E(r)
    • Global min-var pf: single asset w lowest var
    • Efficient frontier: min-var frontier above min-var pf
  7. Risk poolinkg vs Risk sharing
    • Poooling: merge uncorrelated assets; increases exposure to risk (Sharpe and sd incr by n0.5)
    • Sharing: share fixed amt of risk among investors. Sharing + pooling reduces risk (Sharpe incr by n0.5, sd constant)
    • Long run investment (time diversification) equivalent to pooling
  8. Disadvantages of large firms
    • Need to widen UW stds -> pressure on profit
    • Impact of UW error compounded