Portfolio selection, markowitz model
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Portfolio management involves selecting a collection of financial or physical assets to maximize returns while minimizing risk through diversification. The Markowitz model, introduced by Harry Markowitz, provides a framework for selecting the optimal portfolio based on risk-return tradeoffs, highlighting the importance of expected returns and variance. Effective portfolio construction aims to create a diversified mix of investments to achieve the highest possible returns for a given level of risk, while considering systematic and unsystematic risks.
Portfolio selection, markowitz model
- 1. Portfolio Management • Portfolio selection • Markowitz model
- 2. MEANING - PORTFOLIO • It is a collection or combination of financial assets (shares, debentures, government securities) • It can also be called collection of Physical Assets (gold, silver, real estate etc). • Here, it is used for” investment purpose” and not for consumption.
- 3. PORTFOLIO SELECTION • The objective of every rational investor is to maximize his returns and minimize the risk. • Diversification is the method adopted for reducing risk. • It essentially results in the construction of portfolios. • The proper goal of portfolio construction would be to generate a portfolio that provides the highest return and the lowest risk. • Such a portfolio would be known as the optimal portfolio. • The process of finding the optimal portfolio is described as portfolio selection.
- 4. MARKOWITZ MODEL • Modern portfolio theory or portfolio theory was introduced by harry markowowiz with his paper portfolio selection . • The markowitz model describe a set of rigorous statistical procedures used to select the optimal portfolio for wealth maximizing / risk-averse investors. • The model is describing under the framework of a risk-return tradeoff graph.
- 5. MARKOWITZ MEAN VARIANCE MODEL ASSUMPTION • The return on investment adequately summarizes the outcome of the investment • All investors are risk-averse. • Investors are assumed to be rational • Return could be any suitable measure of monetary inflow • Investors base their investment decision on two criteria expected return and variance of return
- 6. DIAGRAM
- 7. EFFICIENT SET OF PORTFOLIO • It is the portfolio that offers the highest excepted return for a given level of risk or one with the lowest level of risk for a excepted return and the line that connect all these efficient portfolios is efficient frontier.
- 8. GRAPH
- 9. SETTING UP OF PORTFOLIO • The portfolio manager will determine how to structure the portfolio based on the restriction and guidelines in the portfolio prospectus. Portfolio prospectus includes; • Fee • Investment objective • Limitation • Names of the portfolio manager
- 10. DIVERSIFICATION Why diversify? • Higher more consistent return • Lower risk • A diversified portfolio will hold a number of securities • Diversification is not having all your money in one basket • Losses in some securities should be offset by gains in others
- 11. How to get the best diversification? • Spread your portfolio among multiple investment vehicles such as cash,stock,mutual fund. • Vary the risk in your securities • Vary your securities by industry
- 12. Diversification of risk TWO TYPES OF RISK; 1. Systematic risk 2. Unsystematic risk
- 13. SELECTION OF OPTIMUM PORTFOLIO • Step 1; use the markowitz portfolio selection model to identify optimal combinations • Step 2; consider riskless borrowing and lending possibilities • Step 3; choose the final portfolio based on your preference for return relatives to risk