![Page 1: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/1.jpg)
Chapter 17RISK AND DIVERSIFICATION
• What is risk aversion, and why are investors, as a group, risk averse?
• What are the general investment implications of risk aversion?
• Why is standard deviation a good measure of risk, and how does an investor compute standard deviations for both individual securities and portfolios?
![Page 2: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/2.jpg)
RISK AND DIVERSIFICATION-Cont.
• What is the impact of security correlations impact portfolio risk?
• What are the benefits of diversification, and how investors achieve them?
• What is the meaning of efficient diversification and modern portfolio theory
![Page 3: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/3.jpg)
What is risk aversion?
• Risk aversion
• Risk aversion and expected returns
• Relative risk aversion and expected returns
![Page 4: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/4.jpg)
Figure 17.1 – Distribution of Yearly Returns of Stocks and T-Bills, 1926-2002
![Page 5: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/5.jpg)
Figure 17.2 – Risk Aversion and Expected Returns
![Page 6: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/6.jpg)
Measuring risk and return: Individual securities
• Measuring returns– Ex-ante or expected returns– Ex-post or historical returns
• Measuring risk– Range– Number of negative outcomes– Standard deviation (or variance)
![Page 7: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/7.jpg)
Calculating standard deviations and security selection
• Ex-ante or expected risk
• Ex-post or historical risk
• Security selection
![Page 8: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/8.jpg)
Figure 17.3 – Risk/Return Graph for Security Selection
![Page 9: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/9.jpg)
Portfolio risk and return
• Portfolio return.– Ex-ante portfolio return, ERp
– Ex-post portfolio return, Mp
![Page 10: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/10.jpg)
Standard deviation of atwo-security portfolio
• Covariance (COV(A,B))
• Correlation coefficient CORR(A,B)
• CORR(A,B) = COV(A,B)/ (SDA)(SDB)
• Standard deviation for a two-security portfolio
• Correlation and portfolio standard deviation
![Page 11: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/11.jpg)
Figure 17.4 – Two-Security Portfolio Combinations with Various Correlations
![Page 12: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/12.jpg)
Investment opportunity set for two-security portfolio
• Minimum variance portfolio
• Standard Deviation of an N-Security Portfolio.
![Page 13: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/13.jpg)
Figure 17.5 – Two-Security Portfolio Combinations of Securities A and E
![Page 14: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/14.jpg)
Diversification
• Diversification across securities• Two types of portfolio risk• Mathematical effects of diversification• Diversification across time• Efficient diversification• How to find an efficient frontier
• Implications for Investors
![Page 15: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/15.jpg)
Figure 17.6 – Example of Diversification Across Securities
![Page 16: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/16.jpg)
Figure 17.7 – Efficient Frontier for Three Stocks
![Page 17: Contemporary Investments: Chapter 17 Chapter 17 RISK AND DIVERSIFICATION What is risk aversion, and why are investors, as a group, risk averse? What are](https://reader030.vdocuments.mx/reader030/viewer/2022032800/56649d255503460f949fb5a2/html5/thumbnails/17.jpg)
Figure 17.8 – Full-Market Efficient Frontier