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Lecture 4: Portfolio Diversification and Supporting Financial Institutions

This document summarizes a lecture on portfolio diversification and supporting financial institutions. It discusses optimal portfolio diversification using multiple assets, efficient portfolio frontiers with two and three assets, beta calculation in the CAPM model, and results from a 1999 survey of individual investors on timing the market, picking individual stocks, and picking mutual funds.

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49 views

Lecture 4: Portfolio Diversification and Supporting Financial Institutions

This document summarizes a lecture on portfolio diversification and supporting financial institutions. It discusses optimal portfolio diversification using multiple assets, efficient portfolio frontiers with two and three assets, beta calculation in the CAPM model, and results from a 1999 survey of individual investors on timing the market, picking individual stocks, and picking mutual funds.

Uploaded by

probson28
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Lecture 4: Portfolio

Diversification and Supporting


Financial Institutions
Economics 252, Spring 2008
Prof. Robert Shiller, Yale University

Optimal Portfolio Diversification


in General Case
Drop assumption of equal weighting,
independence and equal variance
Put xi dollars in ith asset, I=1,..,n, where the
xi sum to $1.
Portfolio expected value
Portfolio variance (two assets) =

Efficient Portfolio Frontier with


Two Assets
Frontier expresses portfolio standard
deviation in terms of portfolio expected
return r rather than in terms of x1.

Portfolio Variance, Three Assets


Portfolio variance =

Efficient Portfolio Frontier

Beta
The CAPM implies that the expected return
on the ith asset is determined from its beta.
Beta (i) is the regression slope coefficient
when the return on the ith asset is regressed
on the return on the market.
Fundamental equation of the CAPM:

Survey of Individual Investors


1999
Trying to time the market, to get out before it
goes down and in before it goes up, is:
1. A smart thing to do; I can reasonably
expect to be a success at it. 11%
2. Not a smart thing to do; I cant
reasonably expect to be a success at it. 83%
3. No opinion 5%

Survey of Individual Investors


1999
Trying to pick individual stocks, for
example, if and when Ford Motor stock will
go up, or IBM stock will go up, is:
1. A smart thing to do; I can reasonably
expect to be a success at it. 40%
2. Not a smart thing to do; I cant
reasonably expect to be a success at it. 51%
3. No opinion 8%

Survey of Individual Investors


1999
Trying to pick mutual funds, trying to figure
out which funds have experts who can
themselves pick which stock will go up, is:
1. A smart thing to do; I can reasonably
expect to be a success at it. 50%
2. Not a smart thing to do; I cant
reasonably expect to be a success at it. 27%
3. No opinion 23%

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