Mean Variance Portfolio Theory

Question 1

Which of the following statements is/are TRUE regarding the assumptions of Markowitz’s mean-variance analysis?

While investors may have different degrees of risk aversion, all investors are risk-averse to some extent.
Investors prefer less risk to more risk for a given level of returns, and more return to less return for a given level of risk .
The expected returns, variances, and covariances of all assets are known.
There are no transactions costs or taxes.
A
I and II only

B
II and IV only

C
III and IV only

D
II, III and IV only

E
I, II, III, and IV

Answer 1

Mean-variance analysis is a fundamental implementation of modern portfolio theory. It asserts that investors can evaluate the risk-return characteristics of investment opportunities based on the expected returns, variances, and correlations of the assets.

Here are the underlying assumptions of mean-variance analysis:

All investors are risk-averse. This means investors prefer less risk to more risk for the same level of expected return, and more return to less return for the same level of risk. While investors may have different degrees of risk aversion, all investors are risk-averse to some extent.
The expected returns, variances, and covariances of all assets are known.
To determine optimal portfolios, investors only need to know the expected returns, variances, and covariances of returns.
There are no transactions costs or taxes.