Portfolio Management- Reading 69: Markowitz’s "Market Efficiency”

I started this part around 3-4 days back and got done with Readings 68 and 69. I wanted to do a blog post on Reading 68- which is humongous. I might do it later during another revision. I plan to finish Port. Management by this Saturday and then start with Derivatives.

The following are the main points from this reading:

Key assumptions of the Markowitz theory–

1. No taxes or transaction costs
2. All investors hold the same mean variance portfolio
3. Everyone can borrow or lend at the risk free rate
4. Unlimited short selling at the risk free rate and the proceeds can then be used for a long position.

Main implications-

1. The market port. is efficient and lies on the efficient frontier
2. Linear relationship betn. the expected return and beta.

However, in case assumptions 3 or 4 don’t hold, then the key implications would be-

1. The market port. can be inefficient and lie below the efficient frontier.
2. The linear reln. betn the expected return and beta will not hold.
3. Beta cannot be correctly used for the estimation of risk adjustments
4. The high risk averse investors will have a higher concentration of low risk stocks/portfolios. And the low risk averse investors will be diversified by holding a small proportion of high risk stocks/portfolios.

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Tags: MarkowitzTheory, Portfolio Management