How the portfolio possibilities curve (PPC) illustrates the benefit of diversification (FRM T1-7)
Вставка
- Опубліковано 29 вер 2024
- When correlations are imperfect, diversification benefits are possible. The portfolio possibilities curve illustrates this and it contains two notable points: the minimum variance portfolio (MVP) and the optimal portfolio (with the highest Sharpe ratio). At the end, I summarize four features of the PPC: 1. correlation, ρ, determines the shape of the PPC; 2. The minimum variance portfolio (MVP) is furthest left (and has an easy analytical solution); 3. The (MVP) also slices the PPC into a lower convex segment and an upper concave segment which contains the dominating efficient portfolios; and 4. The theoretically optimal portfolio has the highest Sharpe ratio (and also has an analytical albeit less easy solution).
[my XLS is here trtl.bz/frm-t1-...]
💡 Discuss this video here in our FRM forum: trtl.bz/2PgOMcj
👉 Subscribe here / bionicturtl. .
to be notified of future tutorials on expert finance and data science, including the Financial Risk Manager (FRM), the Chartered Financial Analyst (CFA), and R Programming!
❓ If you have questions or want to discuss this video further, please visit our support forum (which has over 50,000 members) located at bionicturtle.co...
🐢 You can also register as a member of our site (for free!) at www.bionicturt...
📧 Our email contact is support@bionicturtle.com (I can also be personally reached at davidh@bionicturtle.com)
For other videos in our Financial Risk Manager (FRM) series, visit these playlists:
▶️ Texas Instruments BA II+ Calculator
• Texas Instruments BA I...
1️⃣ Risk Foundations (FRM Topic 1)
• Risk Foundations (FRM ...
2️⃣ Quantitative Analysis (FRM Topic 2)
• Quantitative Analysis ...
3️⃣ Financial Markets and Products: Intro to Derivatives (FRM Topic 3, Hull Ch 1-7)
• Financial Markets and ...
4️⃣ Financial Markets and Products: Option Trading Strategies (FRM Topic 3, Hull Ch 10-12)
• Financial Markets and ...
▶️ FM&P: Intro to Derivatives: Exotic options (FRM Topic 3)
• FM&P: Intro to Derivat...
4️⃣ Valuation and Risk Models (FRM Topic 4)
• Valuation and RIsk Mod...
5️⃣ Market Risk (FRM Topic 5)
• Market Risk (FRM Topic 5)
Coming Soon ....
6️⃣ Credit Risk (FRM Topic 6)
7️⃣ Operational Risk (FRM Topic 7)
8️⃣ Investment Risk (FRM Topic 8)
9️⃣ Current Issues (FRM Topic 9)
▶️ For videos in our Chartered Financial Analyst (CFA) series, visit these playlists:
Chartered Financial Analyst (CFA) Level 1 Volume 1
• Level 1 Chartered Fina...
#bionicturtle #risk #financialriskmanager #FRM #finance #expertfinance
Our videos carefully comply with U.S. copyright law which we take seriously. Any third-party images used in this video honor their specific license agreements. We occasionally purchase images with our account under a royalty-free license at 123rf.com (see www.123rf.com/... we also use free and purchased images from our account at canva.com (see about.canva.co.... In particular, the new thumbnails are generated in canva.com. Please contact support@bionicturtle.com or davidh@bionicturtle.com if you have any questions, issues or concerns.
Is Sharpe ratio or Treynor ratio a better measure of the portfolio diversification?
Hi Ashay, Sharpe and Treynor are both measures of risk-adjusted return, therefore NEITHER is a measure of diversification. Instead, because Treynor's denominator is beta such that its risk metric is systematic risk, Treynor effectively PRESUMES a diversified portfolio and arguably should only be used on approximately those occasions. The Sharpe ratio's denominator is volatility (aka, total risk albeit an imperfect measure of total risk) such that when the portfolio is not well diversified, the Sharpe should be used. Thanks!
Hey I am currently preparing for a frm can drop u phone no. Here please it will be help in studies??
@@sagarsonar7671 how can we differentiate between diversified and non diversified portfolio?
It's through the correlation measure.
Correlation= -1 is well diversified, but in real life it will be in between -1
@@user-st6is9ml4x there is no perfect measure for diversification it's according to the need of portfolio
hi David, thank you very much. Is it possible for you to re-upload the excel file? I think it has been deleted from Dropbox since. I would love to know, how you created the portfolio possibilities curve. Thank you!
hi David, is it possible for you to re-upload the excel file? I think it has been deleted from Dropbox since. I would love to know, how you created the portfolio possibilities curve. Thank you!
I love the spreadsheet, but I think the 3rd term of right hand side is not correct. It should be 2*wA*wB*Cov(A,B), where Cov(A,B)=Corr*sdA*sdB
Yes, thank you for noticing, I did have a formula error (that doesn't manifest during the video while ρ=0). I fixed the formula for portfolio volatility, so it now reads =SQRT(F37^2*$M$10+(1-F37)^2*$M$13+2*F37*(1-F37)*rho_ab*sigma_a*sigma_b). Thank you for your attention to detail!
Hello Sir,
I have a question on the efficient frontier. What I understood that all the portfolios on the efficient frontier plot (that is on the frontier line and below that) are all well diversified.
If this is true, then the risk plotted on the x-axis in a way represents the systematic risk. Although we plot the total risk but in substance it is systematic risk because we have already diversified. Pls help with this particular thought.
Thank you in anticipation
Hi Kaushik, That is true for the straight-line (ie, including the Rf rate) CML where its linear relationship to volatility will also be linear to beta (and keep in mind, the beta is a beta with respect to the Market Portfolio which is only a single point of tangency at the highest Sharpe ratio). But efficiency and diversification both have degrees! Before the Rf rate (ie, the Green PPC), only the Market Portfolio is "most efficient" (highest Sharpe ratio) and under CAPM theory investors will all seek this "very well (most) diversified Portfolio). If you slice a horizonal line (say at 200% leverage in the Market Portfolio), for a given EXPECTED RETRUN (e.g., 19%) you will intersect the CML at a lower sigma than the green line. Each has the same beta, but the non-CML portfolio is less efficient due to some idiosyncratic volatility. We could imagine a mapping but it's non linear. Both efficiency and diversification have degrees, only the CML is highest efficiency and most diversified. Thanks,
@@bionicturtle Hello David,
Thanks for the explanation. You are saying less efficiency between the CML and Non CML portfolio is due to the presence of some degree of idiosyncratic.
And if we remove the risk free and only look at the efficient frontier, how can we prove that the market portfolio is the most diversified?
By saying that it has highest return per risk unit and therefore it is the most efficient and most diversified.
Is that correct?
Is it possible to get the excel worksheet for this please?
A link to the Excel file (XLS) is at the beginning of the video's description above