Risk Aversion and Capital Allocation Risk Tolerance Asset Allocation Capital Allocation Line.

Slides:

Advertisements

Similar presentations

Holding Period Return.

Advertisements

Capital Allocation Between the Risky Asset and the Risk-Free Asset.

MIP/MB-IPB/08 1 MANAJEMEN INVESTASI DAN PORTOFOLIO Lecture 3a: Portfolio Management.

Introduction The relationship between risk and return is fundamental to finance theory You can invest very safely in a bank or in Treasury bills. Why.

5.5Asset Allocation Across Risky and Risk Free Portfolios 5-1.

1 Risk, Returns, and Risk Aversion Return and Risk Measures Real versus Nominal Rates EAR versus APR Holding Period Returns Excess Return and Risk Premium.

Capital Allocation to Risky Assets

LECTURE 5 : PORTFOLIO THEORY

Risk and Return: Past and Prologue CHAPTER 5. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Holding Period Return.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Risk and Return: Past and Prologue CHAPTER 5.

Capital Asset Pricing Model Applied covariance: Project Part 1.

INVESTMENTS | BODIE, KANE, MARCUS ©2011 The McGraw-Hill Companies CHAPTER 7 Optimal Risky Portfolios 1.

Notes – Theory of Choice

Risk and Return: Past and Prologue

1 Fin 2802, Spring 10 - Tang Chapter 6: Asset Allocation Fina2802: Investments and Portfolio Analysis Spring, 2010 Dragon Tang Lecture 9 Capital Allocation.

Asset Management Lecture Two. I will more or less follow the structure of the textbook “Investments” with a few exceptions. I will more or less follow.

McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 7-1 Capital Allocation Between the Risky Asset and the Risk-Free.

Chapter 11 In-Class Notes. Types of Investments Mutual funds Exchange traded funds Stocks Primary versus secondary market Types of investors: institutional,

Risk Aversion and Capital Allocation to Risky Assets

FIN352 Vicentiu Covrig 1 Risk and Return (chapter 4)

Risk and Risk Aversion Chapter6. W = 100 W 1 = 150 Profit = 50 W 2 = 80 Profit = -20 p =.6 1-p =.4 E(W) = pW 1 + (1-p)W 2 = 6 (150) +.4(80) = 122  2.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Efficient Diversification CHAPTER 6.

Return and Risk: The Capital Asset Pricing Model Chapter 11 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

INVESTMENTS | BODIE, KANE, MARCUS ©2011 The McGraw-Hill Companies CHAPTER 6 Risk Aversion and Capital Allocation to Risky Assets.

Capital Allocation Between The Risky And The Risk-Free Asset

FIN638 Vicentiu Covrig 1 Portfolio management. FIN638 Vicentiu Covrig 2 How Finance is organized Corporate finance Investments International Finance Financial.

McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6 Risk and Risk Aversion.

Risk Aversion and Capital Allocation to Risky Assets

Investments, 8 th edition Bodie, Kane and Marcus Slides by Susan Hine McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights.

An overview of the investment process. Why investors invest? By saving instead of spending, Individuals trade-off Present consumption For a larger future.

Risk Premiums and Risk Aversion

Optimal Risky Portfolio, CAPM, and APT

The Capital Asset Pricing Model (CAPM)

Theory 1: Risk and Return The beginnings of portfolio theory

Risk and Capital Budgeting Chapter 13. Chapter 13 - Outline What is Risk? Risk Related Measurements Coefficient of Correlation The Efficient Frontier.

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 1 Chapter 6.

McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 7 Capital Allocation Between The Risky And The Risk-Free.

Dr. Tucker Balch Associate Professor School of Interactive Computing Computational Investing, Part I 023: Sharpe Ratio Find out how modern electronic markets.

FIN437 Vicentiu Covrig 1 Portfolio management Optimum asset allocation Optimum asset allocation (see chapter 7 Bodie, Kane and Marcus)

Efficient Diversification CHAPTER 6. Diversification and Portfolio Risk Market risk –Systematic or Nondiversifiable Firm-specific risk –Diversifiable.

Return and Risk The Capital Asset Pricing Model (CAPM)

Risk and Return: Past and Prologue Risk Aversion and Capital Allocation to Risk Assets.

Efficient Diversification II Efficient Frontier with Risk-Free Asset Optimal Capital Allocation Line Single Factor Model.

Return and Risk: The Asset-Pricing Model: CAPM and APT.

5-1 CHAPTER 5 Risk and Rates of Return Rates of Return Holding Period Return: Rates of Return over a given period Suppose the price of a share.

Investments, 8 th edition Bodie, Kane and Marcus Slides by Susan Hine McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights.

INVESTMENTS | BODIE, KANE, MARCUS Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin CHAPTER 6 Risk Aversion and.

Capital Market Theory. Outline  Overview of Capital Market Theory  Assumptions of Capital Market Theory  Development of Capital Market Theory  Risk-Return.

PORTFOLIO THEORY. Risk & Return Return over Holding Period Return over multiple periods Arithmetic Mean Geometric Mean Dollar Averaging or IRR Return.

Chapter 5 Risk and Return: Past and Prologue Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin.

Chapter 6 Efficient Diversification Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin.

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 6-1 Chapter 6.

FIN437 Vicentiu Covrig 1 Portfolio management Optimum asset allocation Optimum asset allocation (see chapter 8 RN)

McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. Risk and Return: Past and Prologue CHAPTER 5.

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 1 Chapter 6.

Risk Aversion and Capital Allocation to Risky Assets

Risk Aversion and Capital Allocation to Risky Assets

The Capital Asset Pricing Model

Risk and Return: Past and Prologue

Risk and Return: Past and Prologue

Capital Allocation to Risky Assets

Risk and Return: Past and Prologue

Risk and Return: Past and Prologue

Capital Allocation to Risky Assets

Risk Aversion and Capital Allocation to Risky Assets

Capital Allocation Between The Risky And The Risk-Free Asset

2. Building efficient portfolios

Risk Aversion and Capital Allocation to Risky Assets

Risk Aversion and Capital Allocation

Risk and Return: Past and Prologue

Presentation transcript:

Risk Aversion and Capital Allocation Risk Tolerance Asset Allocation Capital Allocation Line

Investments 82 Risk Premium and Risk Aversion  Risk Premium: E[r] - r f  It is compensation for risk  Risk Measure*:   (Std. Dev. )  Risk Aversion coeff: A * just one of them

Investments 83 Risk Premium and Risk Aversion  Example  Market portfolio E[r] = 12%  Market portfolio  = 20%  Risk-free rate (T-bill) = 4%  Risk premium: E[r] - r f = 8%  Risk aversion coefficient: A = 0.08/(0.5*0.20^2) = 4

Investments 84 Speculation vs. Gambling  Speculation (i.e. Investing)  Taking risk for extra reward  Higher investors’ risk aversion requires higher expected returns  Risk premium: E[r] - r f > 0  Odds are in your favor  Gambling  Risk is the reward  Risk premium: E[r] - r f < 0  Odds are against you

Investments 85 Asset Allocation  How to allocate your fund among the following asset classes? Investment Funds StockBondT - Bills Risky Assets Risk-Free Asset

Investments 86 Asset Allocation  Risky and Risk-Free Assets  Percentage to invest in risky asset  Risky asset: a stock or a stock portfolio  Percentage in risk-free asset  Risk-free asset: 30-day T-bill as proxy  Issues  Examine risk/return tradeoff  Demonstrate how different degrees of risk aversion will affect allocations between risky and risk-free assets

Investments 87 Asset Allocation  Moments of asset returns  Moments of portfolio C return  Example: w = 0.75

Investments 88 Capital Allocation Line  How much in risky asset … Capital Allocation Line Risky Portfolio w = 0.75 Risk-Free Asset

Investments 89 Capital Allocation Line  w > 1, what does that mean?  Find the E[r c ] and SD[r c ] with w = 1.2  Leverage  Investing 120% of wealth in risky asset  Using margin borrowing  Higher expected return than the risky asset  Higher volatility to go with the higher return

Investments 810 Capital Allocation Line with Borrowing Capital Allocation Line: Borrowing at 10% Part Risky Portfolio w = 1.2 Risk-Free Asset

Investments 811 Capital Allocation Line  Sharpe (reward-to-variability) Ratio

Investments 812 Capital Allocation Line  Risk Tolerance and Allocation  Greater risk aversion leads to higher allocation to risk-free asset  Lower risk aversion leads to greater allocation to risky asset  Willingness to accept extremely higher risk for higher return may lead to leveraged position

Investments 813 How to find your portfolio allocation? Example 1  You desire 12% return for your portfolio: 12% = (1-w)*7%+w*15% or w = 62.5% Std. Dev. = 62.5%*22% = 13.75% Example 2  You desire risk no more than 10% for your portfolio: w*Std. Dev. = 10% or w = 45.45% Return = ( %)*7%+45.45*15% = 10.64%

Investments 814 Wrap-up  How does risk aversion affect expected returns?  Is investment a form of gambling???  What is the Capital Allocation Line?  How risk tolerance affects asset allocation?