Theories Of Markowitz Portfolio Theory
One of the major area of finance is optimizing the portfolio. Basically, portfolio theory deals with the risk and value of portfolio instead of individual securities, which is known as Markowitz portfolio theory that is suggested by Harry Markowitz in his article “Portfolio selection” in the Journal of Finance. Markowitz portfolio theory basically helps in making optimum portfolio by interpreting, and evaluating risk and return of different risky assets. Basically, the portfolio theory is all about analyzing the balance in between the minimizing risk and maximizing return. However, the objective of this theory is to select one’s investment in that which could diversify the risk without reducing the expected return. …show more content…
The portfolio manager would offer same risky portfolio to every clients without knowing their degree of risk aversion. However, when clients choose their desire point in the CAL, risk aversion comes into play. Investor who are more risk averse would invest on the risk free assets whereas the less risk averse investor would invest in optimal risky portfolio in comparison to less risk averse, however both investor would use portfolio P as optimal risky investment vehicle, which result is known as separation property. Separation property indicates that portfolio selection problem can be divided or separated between 2 different independent tasks. Talking about the first task, it is about determining the optimal risky portfolio which is technical purely. Here, given the set of input list, regardless the risk aversion the best risky portfolio is same for all investors. Similarly, the second task is about the capital allocation, which is personal preference. In such case investor or say client are themselves the decision maker.
Similarly, the optimal risky portfolio for various clients/investor can differ as a result of constraints on dividend yield, short sales, tax consideration, or other investor preferences. According to the book, few portfolios can be enough to serve the demand of the various investor. Looking upon the mutual fund industry on theoretical basis, if the optimal portfolio is similar for every investor, then the expert/professional management is less costly and also more efficient. Single management firm can provide service to the large number of investor with a small increase in administrative