Mid-Term Flashcards
How is James’s risk aversion coefficient estimated from questionnaire scores?
By finding the median score and using interpolation between known score ranges
What is a risk aversion coefficient?
A measure of how much an investor dislikes risk, with higher values indicating greater aversion to risk.
What does a low risk aversion coefficient imply about an investor’s preferences?
They are more comfortable with taking on risk for potentially higher returns.
How do higher questionnaire scores relate to risk aversion?
Higher scores indicate lower risk aversion.
How do you calculate the weight of an asset in a portfolio?
Divide the value of the asset by the total value of the portfolio.
What is the formula for the expected return of a two-asset portfolio?
E(Rp)=W e×E(R e)+W β×E(R β).
What does the weight of equities in a portfolio represent?
The percentage of the total investment allocated to equities.
What two components are needed to calculate the portfolio’s expected return?
The weights of each asset and their individual expected returns.
Why is the weighted average used to calculate portfolio return?
It reflects each asset’s contribution to the overall return based on its proportion in the portfolio.
What is the formula for the standard deviation of a two-asset portfolio?
σp=(We2×σe2)+(Wβ2×σβ2)+(2×We×Wβ×σe×σβ×ρₑβ).”
What does correlation between assets indicate?
How closely the returns of the assets move together.
Why is correlation important in portfolio risk calculation?
It affects how much diversification benefits reduce risk.
What is the impact of a high correlation between two assets on portfolio risk?
Less reduction in risk due to limited diversification benefits.
If two assets have a correlation of zero, what effect does this have on portfolio risk?
Their movements do not influence each other, allowing for potentially lower risk.
What is a minimum-variance portfolio?
The portfolio with the lowest possible risk for a given set of assets.
