The aim of this class is to examine the Markowitz(1952) approach to optimal portfolio selection. The class will also examine the evaluation of fund performance. In particular, the class considers the use of linear factor models (asset pricing models) to evaluate fund performance. The class explores issues relating to optimal portfolio choice and the evaluation of fund performance.
The class provides opportunities for students to develop and demonstrate knowledge, understanding and skills in the following areas:
i) Knowledge Based Outcomes:
On completion of the class students should be able to:
- discuss the approach of building optimal portfolios using the Markowitz model;
- explain the estimation risk problem in sample mean-variance portfolios;
- critically evaluate the alternative approaches to solve the estimation risk problems in mean-variance analysis;
- discuss whether optimal mean-variance strategies can outperform naïve diversification strategies;
- explain the Capital Asset Pricing Model and multifactor models of asset pricing;
- discuss the main performance measures used to evaluate the performance of managed funds;
- use Excel to solve small-scale mean-variance problems and to estimate the performance of managed funds.
ii) Skills Outcomes:
On completion of this class students should be able to demonstrate that they can:
- read and understand academic research papers;
- use computational skills in undertaking empirical research through the use of Excel in the areas covered by the class that are also applicable to other areas of finance;
- use analytical skills in interpreting empirical findings and recognising some of the limitations faced by empirical researchers;
- write short research papers with appropriate structure and content.
TEACHING AND LEARNING
The teaching and learning strategy adopted in this class to meet the learning outcomes will use a variety of approaches. Students will learn through directed reading, independent reading, formal class contact time in lectures and workshops, undertaking empirical research on own/groups, independent evaluation of research findings, and the use of electronic resources. The formal class contact time will be used to introduce the topics of mean-variance analysis, asset pricing, and fund performance. We will also consider how to use Excel to solve mean-variance problems and to estimate different performance measures to evaluate managed funds.
Cuthbertson, K. and D. Nitzsche, 2008, Investments, Wiley. (CN)
Bodie, Z., Kane A., and Marcus AJ. , 2010, Investments and Portfolio Theory (Global Edition), McGraw Hill.
Brandt, M.W., 2010, Portfolio choice problems, in Y. Ait-Sahalia and L.P. Hansen (eds.), Handbook of Financial Econometrics, 2010, 269-336.
Kan, R. and D.R. Smith, 2008, The distribution of the sample minimum-variance frontier, Management Science, 54, 1364-1380.
Tu, J. and G. Zhou, 2009, Markowitz meets Talmud: A combination of sophisticated and naïve diversification strategies, Journal of Financial Economics, forthcoming.
DeMiguel, V., Garlappi, L. and R. Uppal, 2009, Optimal versus naïve diversification: How inefficient is the 1/N strategy?, Review of Financial Studies, 22, 1915-1953.
Linear Factor Models
Fama, E.F. and K.R. French, 2004, The CAPM: Theory and evidence, Journal of Economic Perspectives, 18, 25-46.
Aragon, G. and W.E. Ferson, 2008, Portfolio performance evaluation, Foundations and Trends in Finance, 2, 83-190.
Fama, E.F. and K.R. French, 2010, Luck versus skill in the cross-section of mutual fund returns, Journal of Finance, 65, 1915-1947.
Cuthbertson, K., Notzsche, D. and N. O’Sullivan, 2010, Mutual fund performance: Measurement and evidence, Financial Markets, Institutions, and Instruments, 19, 95-187.
|Session||Lecture Title / Subject / Content|
|1||Introduction to mean-variance analysis. Use of sample mean-variance portfolios.|
|2||Estimation risk problem in mean-variance analysis. Proposed solutions to the estimation risk problem.|
|3||Empirical survey. Linear factor models.|
|4||Linear factor models – empirical evidence. Introduction to evaluating fund performance.|
|5||Unconditional performance measures. Conditional performance evaluation.|
|6||Survey of empirical studies. Revision.|