MarkowitzModel.pptVIP

Markowitz Model Markowitz Model Markowitz Model: Solution Single Index Model Single Index Model (Cont’d) Single Index Model (Cont’d) Single Index Model (Cont’d) Single Index Model Solution * For 3-stock portfolio, short selling allowed Eg. RA= 20% RB= 10% RC= 8% ?2A=100 ?2B=25 ?2C=16 ?AB= 15 ?AC= 20 ?BC= 4 Form the Lagrangian For R* = 15% wA = 50.214% wB = 48.715% wC = 1.075% Standard Dev = 6.22% For R* = 20% wA = 91% wB = 56% wC = -47% (short sale) Standard Dev = 9.47% Rt= A + BRmt + et E(Rt) = A + BE(Rmt) Cov(ei,ek)=0 E(ei)=0 Cov(ei,Rm)=0 ?2p=?Pi[Ri - E(R)]2 by substitution ?2=?Pi[A + BRmt +ei -A - BE(Rm)]2 ?2=?Pi{B[Rmi-E(Rm)] + ei}2 ?2=?Pi{B2[Rmi-E(Rm)]2 +ei2+2B[Rmi-E(Rm)] ei} ?2p= B2p ?2m + ?2e ?2p= B2p?2m + ?2ep We also know that Bp= Cov(Rp, Rm)/ ?2m Bp=?wjBj ?2ep= ?wj2 ?2ej Hence, the portfolio variance is: ?2p= (?xjBj )2?2m + ?xj2 ?2ej For 3-stock portfolio, short selling allowed Eg. RA= 20% RB= 10% RC= 8% ?2A?=20 ?2B?=15 ?2C?=9 ?A= 1.5 ?B= 0.75 ?C= 0.50 Form the Lagrangian When R* = 15% wA = 0.57 wB = 0.08 wC = 0.35 Standard Deviation = *