- CFA Level 2: Portfolio Management – Introduction
- Mean-Variance Analysis Assumptions
- Expected Return and Variance for a Two Asset Portfolio
- The Minimum Variance Frontier & Efficient Frontier
- Diversification Benefits
- The Capital Allocation Line – Introducing the Risk-free Asset
- The Capital Market Line
- CAPM & the SML
- Adding an Asset to a Portfolio – Improving the Minimum Variance Frontier
- The Market Model for a Security’s Returns
- Adjusted and Unadjusted Beta
- Multifactor Models
- Arbitrage Portfolio Theory (APT) – A Multifactor Macroeconomic Model
- Risk Factors and Tracking Portfolios
- Markowitz, MPT, and Market Efficiency
- International Capital Market Integration
- Domestic CAPM and Extended CAPM
- Changes in Real Exchange Rates
- International CAPM (ICAPM) - Beyond Extended CAPM
- Measuring Currency Exposure
- Company Stock Value Responses to Changes in Real Exchange Rates
- ICAPM vs. Domestic CAPM
- The J-Curve – Impact of Exchange Rate Changes on National Economies
- Moving Exchange Rates and Equity Markets
- Impacts of Market Segmentation on ICAPM
- Justifying Active Portfolio Management
- The Treynor-Black Model
- Portfolio Management Process
- The Investor Policy Statement
Markowitz, MPT, and Market Efficiency
The portfolio concepts presented in section I trace their roots to Markowitz groundbreaking work.
The Efficient Market Hypothesis (EMH) contents that the market correctly prices all securities.
MPT argues that all investors should hold the same portfolio of diversified securities correctly priced by the efficient market.
The conclusion of MPT would argue for passive management of investor portfolios.
- With this in mind, some portfolio managers have consistently out-returned a recognized market index over time.
- Further, sometimes asset mispricings are correctly identified by portfolio managers and these anomalies have been exploited to generate excess returns above the market index benchmark. These issues can serve as a foundation for justifying active portfolio management over passive management.
CAPM assumes that investors face no restrictions on lending and (more importantly) borrowing at the risk free rate, as well as the ability to short sell.
In reality these limitations frequently exist. Any investor can lend at the risk free rate buy purchasing a bond deemed as having extremely low risk.
Investors lack the ability to command the low borrowing rates of say the US, Japanese, or German sovereign governments (which would be the proxies for a risk free rate, despite a total risk free nature).
Many investors cannot short sell (even some big institutional types, such as pensions).
Those investors who can short sell could opt to borrow at their cost and sell short some of the portfolio.
Ultimately, with a spread between the lending (lower) and borrowing (higher) rates imposed on investor reality and restrictions on short selling, the market can exhibit inefficiencies.
Inefficiency causes a distortion in the linear nature of the relationship between expected returns and beta.