Escolar Documentos
Profissional Documentos
Cultura Documentos
Speculation Gamble
Taking considerable Bet on an uncertain
risk for a outcome for enjoyment
commensurate gain Parties (should) assign
Parties have the same probabilities
heterogeneous to the possible
expectations outcomes
So there are trades Gambling happens
among rational parties because it is fun!
How to compare?
Each portfolio receives a utility score to
assess the investors risk/return trade off
U E r A
1 2
2
= utility or welfare (a measure of happiness)
[] = expected return on the asset or portfolio
= coefficient of risk aversion
2 = variance of returns
= a scaling factor (well see later why turn useful)
2
A = coefficient of risk aversion. Interpretation:
A>0 - Risk Averse. Penalizes risk. Will want a
larger risk premium for riskier investments.
A=0 - Risk Neutral. A pure trader, only
concerned about expectation. Indifferent to a
fair game.
A<0 - Risk Lover. Adjusts utility up for risk
because enjoys the risk. A gambler, bored with
risk-free, will prefer for riskier investments.
INVESTMENTS | BODIE, KANE, MARCUS 6-9
Table 6.2 Utility Scores of Alternative Portfolios for
Investors with Varying Degree of Risk Aversion
U Er A 2
1
2
And E rA E rB
A B
Q. How do you find a family of portfolios
you are indifferent to?
INVESTMENTS | BODIE, KANE, MARCUS 6-12
Utility Indifference Curve
$113,400 $96,600
wE 0.54 wB 0.46
$210,000 $210,00
These weights are within the risky portfolio
Q. What is the risk-free vs risky composition?
INVESTMENTS | BODIE, KANE, MARCUS 6-16
Basic Asset Allocation
Let y = weight of the risky portfolio P, in the
complete portfolio;
(1-y) = weight of risk-free assets:
$210,000 $90,000
y 0.7 1 y 0.3
$300,000 $300,000
$113,400 $96,600
E: 0.378 B: 0.322
$300,000 $300,000
These weights are within the entire portfolio
Risky Risk-free
E(rp) = 15% rf = 7%
p = 22% rf = 0%
y = % in p (1-y) = % in rf
E rC rf yE rp rf
risk premium
E rc 7 y15 7
C y P 22 y
C
E rC rf
P
E rP rf 7 C
8
22
E rP rf 8
Slope Intercept rf 7
P 22
y =1
Q. Whats the
value of y
here?
What does it
mean?
y =0
CAL kinks at P
You
borrow
You lend
[ ] = + ([ ] )
Variance:
y
2
C
2 2
P
E rC
1
U A C
2
2
U rf y E rp rf A y P
1
2
2 2
U is a quadratic function of y
U ay yb c
2
Example:
rf = 7%
E(rp) = 15%
p = 22%
E rC
1
U A C
2
U rf y E rp rf A y P
1
2
2 2
E rp rf
The maximize w.r.t. y
ymaxU
A 2
P
2
For example :
U 0.05, 0.09