Business
Portfolio Risk
Portfolio risk refers to the potential for loss or underperformance of a collection of investments. It is influenced by the individual risks of the assets within the portfolio as well as their correlations. Diversification and risk management strategies are used to mitigate portfolio risk and optimize the balance between potential returns and potential losses.
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7 Key excerpts on "Portfolio Risk"
eBook - PDFInvestments
Analysis and Management
- Gerald R. Jensen, Charles P. Jones(Authors)
- 2020(Publication Date)
- Wiley(Publisher)
Portfolio Return and Risk When we analyze investment returns and risks, we must consider the total portfolio held by an investor. Individual security risk and return is important, but it is the risk and return to the investor’s portfolio that ultimately matters. Optimal portfolios can be constructed if portfolios are diversified correctly. As we learned in Chapter 1, an investor’s portfolio is his or her combination of assets. As we will see, Portfolio Risk is a unique characteristic and not simply the sum of individual security risks. A security may have high risk if held by itself, but much less risk when held in a portfolio of securities. Since investors are concerned primarily with the risk to their total wealth, as represented by their portfolio, individual stocks are risky only to the extent that they add risk to the portfolio. 1 See Frank J. Fabozzi, Francis Gupta, and Harry M. Markowitz, “The Legacy of Modern Portfolio Theory,” The Journal of Investing (Fall 2002): 7–22. Investments Intuition Clearly, investors thought about diversifying a portfolio before Markowitz’s landmark work. But they did so in general terms. And it is true that not everyone uses his analysis today. However, the tenets of portfolio theory are widely used today, by themselves or in conjunction with other tech-niques, and by both institutional investors and individual investors. 178 Chapter 7 Portfolio Theory Portfolio Expected Return Portfolio weights The percentages of a portfolio’s total value that are invested in each portfolio asset are referred to as portfolio weights , which we will denote by w . The combined portfolio weights sum to 100 percent of total investable funds, or 1.0, indicating that all portfolio funds are invested.
eBook - PDFInvestments
Analysis and Management
- Gerald R. Jensen, Charles P. Jones(Authors)
- 2019(Publication Date)
- Wiley(Publisher)
Portfolio Return and Risk When we analyze investment returns and risks, we must consider the total portfolio held by an investor. Individual security risk and return is important, but it is the risk and return to the investor’s portfolio that ultimately matters. Optimal portfolios can be constructed if portfolios are diversified correctly. As we learned in Chapter 1, an investor’s portfolio is his or her combination of assets. As we will see, Portfolio Risk is a unique characteristic and not simply the sum of individual security risks. A security may have high risk if held by itself, but much less risk when held in a portfolio of securities. Since investors are concerned primarily with the risk to their total wealth, as represented by their portfolio, individual stocks are risky only to the extent that they add risk to the portfolio. 1 See Frank J. Fabozzi, Francis Gupta, and Harry M. Markowitz, “The Legacy of Modern Portfolio Theory,” The Journal of Investing (Fall 2002): 7–22. Investments Intuition Clearly, investors thought about diversifying a portfolio before Markowitz’s landmark work. But they did so in general terms. And it is true that not everyone uses his analysis today. However, the tenets of portfolio theory are widely used today, by themselves or in conjunction with other tech- niques, and by both institutional investors and individual investors. 178 Chapter 7 Portfolio Theory Portfolio Expected Return Portfolio weights The percentages of a portfolio’s total value that are invested in each portfolio asset are referred to as portfolio weights, which we will denote by w. The combined portfolio weights sum to 100 percent of total investable funds, or 1.0, indicating that all portfolio funds are invested.
eBook - ePubA Wealth of Common Sense
Why Simplicity Trumps Complexity in Any Investment Plan
- Ben Carlson(Author)
- 2015(Publication Date)
- Bloomberg Press(Publisher)
CHAPTER 3 Defining Market and Portfolio RiskThe stock market is a giant distraction to the business of investing.—John BogleIn the 1960s there was a French film called The Lovers (Les Amants). It turned out to be a little risqué for some people in the Midwest. The state of Ohio ruled the film to be obscene and pornographic. The case eventually made it all the way to the Supreme Court, where it was ruled that the movie was not, in fact, too obscene to be viewed by the public. Justice Potter Stewart had this to say when describing the film and pornography in general, “I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description [‘hard-core pornography’], and perhaps I could never succeed in intelligibly doing so. But I know it when I see it, and the motion picture involved in this case is not that.”1Most investors assume that risk is a form of “I know it when I see it.” Unfortunately, risk is nearly impossible to define because it has so many permutations. To some it's volatility. To others it's losing money. Longevity risk—outliving your money—is probably the biggest risk of all. Then you have all of the risks within each investment class: duration, interest rates, earnings shortfalls, recessions, permanent impairment, innovation, competition, and so on. The list could seemingly go on forever.If there is an ironclad rule in the world of investing, it's that risk and reward are always and forever attached at the hip. You can't expect to earn outsized gains if you don't expose yourself to the possibility of outsized losses. If you are seeking the safety of your principal, you have to be willing to give up on the prospect of higher returns. If you are seeking to compound your wealth through higher investment returns, you have to be willing to let go of the idea that your money won't fluctuate and possibly fall in the short to intermediate term. You have to seek a balance within your own portfolio, but understand that there is no such thing as a free lunch.
eBook - PDF- Giancarlo Nota(Author)
- 2011(Publication Date)
- IntechOpen(Publisher)
0 Portfolio Risk Management: Market Neutrality, Catastrophic Risk, and Fundamental Strength N.C.P. Edirisinghe 1 and X. Zhang 2 1 College of Business, University of Tennessee, Knoxville 2 College of Business, Austin Peay State University, Clarksville U.S.A. 1. Introduction Design of investment portfolios is the most important activity in the management of mutual funds, retirement and pension funds, bank and insurance portfolio management. Such problems involve, first, choosing individual firms, industries, or industry groups that are expected to display strong performance in a competitive market, thus, leading to successful investments in the future; second, it also requires a decision analysis of how best to periodically rebalance such funds to account for evolving general and firm-specific conditions. It is the success of both these functions that allows a portfolio manager to maintain the risk-level of the fund within acceptable limits, as specified by regulatory and other policy and risk considerations. This chapter presents a methodology to deal with the above two issues encountered in the management of investment funds. While there is an abundance of literature on Portfolio Risk management, only a few investment managers implement disciplined, professional risk management strategies. During the stock market bubble of the late 90s, limiting risk was an afterthought, but given the increased stock market volatilities of the last decade or so, more managers are resorting to sophisticated quantitative approaches to Portfolio Risk management. Active risk management requires considering long-term risks due to firm fundamentals as well as short-term risks due to market correlations and dynamic evolution. The literature related to the former aspect often deals with discounted cash flow (DCF) models, while the latter topic is mainly dealt within a more quantitative and rigorous risk optimization framework.
eBook - ePub- R. Stafford Johnson(Author)
- 2014(Publication Date)
- Bloomberg Press(Publisher)
CHAPTER 7 Portfolio EvaluationIntroduction
In the last chapter, we examined how to measure the return and risk of stocks. In an efficient market, investors, however, either individually or through an investment fund, can attain better return-risk opportunities by investing in a portfolio. In this chapter, we analyze portfolios, with the emphasis being on stock portfolios.Portfolio analysis consists of the evaluation and selection of the financial assets that makeup the portfolio. As with individual security evaluation, stock portfolio evaluation entails measuring the characteristics of the portfolio, with the most important properties being the portfolio expected rate of return and risk. Portfolio selection, in turn, involves finding what proportion of investment funds to allocate to each security to give the portfolio either the maximum expected return for a given risk or the minimum risk given a specified return. In this chapter, we evaluate portfolios of risky stocks in terms of their expected portfolio return and risk, and in Chapter 8, we focus on portfolio selection. We begin by examining the relationship between portfolio return and risk and the relationship between Portfolio Risk and number of securities in the portfolio. Next, we introduce a risk-free security and show how investors can obtain different return-risk combinations with different allocations of their investment funds to the risk-free security and a portfolio of risky stocks.Portfolio Return and Risk
A portfolio can be described by the proportion of investment funds allocated to each security in it. For example, suppose an individual invested $1,000 in three stocks, denoted X1 , X2 , and X3 . Her stock portfolio would be described by the proportion of investment funds ($1,000), denoted as wi
eBook - PDF- A. Clare, C. Wagstaff(Authors)
- 2011(Publication Date)
- Palgrave Macmillan(Publisher)
However, when returns are less well correlated, Markowitz showed that the risk involved in holding these assets together in a portfolio is lower than the sum of individual risks of each asset in the portfolio. Today most investors, including pension funds, hold portfolios that can often consist of hundreds of individual assets. Markowitz also explained the idea of an efficient portfolio: a concept used by many of the risk optimizer models employed by today’s fund managers, asset allocators and investment advisers. An efficient portfolio is one that generates the highest expected return from a set of assets for a desired level of risk. Alternatively, an efficient portfolio could be described as one that embodies the lowest level of risk for any required return. Measuring risk The return on an individual asset is just the difference in the value of the asset at the end of the period compared with the value at the beginning of the period, plus any income earned from holding that asset, divided by the value of the asset value at the start of the period. The average of this return over time is often used as a useful summary measure of an asset’s performance. The historic aver- age return is often used as a proxy for future expected returns. Even when it is not, when investment professionals talk about expected return, they generally mean the expected average return over a particular period. 3 Risk, or risky, assets are those that are not risk-free. Indeed, very few assets are. Therefore, the expected return on a risky asset should incorporate one or a number of risk premia as potential compensation for assuming these risks. For example, corporate bond inves- tors would expect to be compensated for the possibility of the issuer defaulting on their obligations, for the relative illiquidity of the bonds and for the volatility in the price of the bonds. We consider risk premia in Chapter 10.
eBook - PDF- Scott Besley, Eugene Brigham, Scott Besley(Authors)
- 2021(Publication Date)
- Cengage Learning EMEA(Publisher)
Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 8-3a Firm-Specific Risk Versus Market Risk From our discussion of Portfolio Risk, you should have concluded that an individual stock (or other investment) generally is less risky when it is held in a portfolio that includes other investments than when it is held by itself. In other words, some of the risk associated with an in- dividual stock can be eliminated by combining it with other investments to form a diversified portfolio. But we know that most stocks are positively correlated, because most companies, and thus their stocks, tend to do well when the economy is strong and to do poorly when it is weak. 6 So, how do investors eliminate some of an indi- vidual stock’s risk by adding it to a portfolio that contains a bunch of positively correlated investments? To see more precisely how diversification works, consider Figure 8.2. This figure shows how Portfolio Risk is affected by forming ever larger portfolios of randomly selected stocks listed on the New York Stock Exchange (NYSE). Standard deviations are plotted for an average one-stock portfolio, for a two-stock portfolio, and so on, up to a portfolio consisting of all common stocks listed on the NYSE. As the graph illustrates, the riskiness of a portfolio consisting of average NYSE stocks generally tends to decline and to approach some minimum limit as the size of the portfolio increases. The figure shows that almost half of the riskiness inherent in an average individual stock can be eliminated if the stock is held as part of a reasonably well-diversified portfolio—namely, a portfolio containing 40 or more stocks.
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