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How do i find the weights w(1), w(2), and w(3) of a market portfolio, given that the market conists of 3 securities S(1), S(2), S(3), with

expected returns m(1) = 10%, m(2) = 15%, m(3) = 20%

standard deviations d(1)= 0.28, d(2) = 0.24, d(3) = 0.25

and correlations between returns are C(1,2) = 0.10, C(2,3) = 0.20, C(3,1) = 0.25

respectively.

2007-11-20 02:14:19 · 2 answers · asked by drummanmatthew 2 in Business & Finance Other - Business & Finance

2 answers

The goal is to find weights such that maximum 'average' return is achieved irrespective of actual returns ..

You can try 'trial & error' ...

for example, if you put 100% weight into (3) your (standard deviation) return will be 20% +/- 5% i.e. between 15% and 25% ...

However at the low end (15%) you might have been better off with some weight of (2) .. especially if (2) goes up as (3) goes down (for which you need correlation between 2 & 3) ...

Since C(2,3) = 0.20 this implies that when (3) is at -5%, (2) will be at approx -1% (whatever ..) .. so return on (2) wil be approx 14% .. this is less than (3) worse case, so answer is :-

100% (3) (and zero for other two)

2007-11-20 03:02:28 · answer #1 · answered by Steve B 7 · 0 0

oftentimes, considering the fact that we've not got a crystal ball, many professionals propose a varied portfolio; this suggests which you are going to hold many diverse asset training that isn't upward push or fall in tandem; it is noted as correlation. in fact, some bypass so a long thank you to declare as they want an asset classification to be in decline to substantiate they're thoroughly varied. in this ecosystem, all risky components are being dragged down; in this situation, possibility loose components will supply the mandatory diversification.

2016-10-17 12:22:56 · answer #2 · answered by Erika 4 · 0 0

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