Portfolio Markowitz Model Simple Diversification Problems of vast Diversification The Markowitz Model assumptions

1. Portfolio Markowitz Model
• Harry Markowitz
• Article in Journal of Finance in March 1952
• Importance of Correlation among the different stocks’ returns
• Also Showed level of expected return in group of securities,
one security dominates the other
• Knowledge of the correlation coefficient between all possible
securities combination is required
• “ Markowitz algorithms “ to minimise the portfolio variance

2. Simple Diversification
• Portfolio risk reduced by the simple diversification
• Assets may Vary from stocks to different types of bonds
• Diversification reduces the unsystematic risk or unique risk

3. Problems of vast Diversification
• Purchase of poor performers
• Information inadequacy
• High research cost
• High transaction cost

4. The Markowitz Model
Holding 2 Stocks is less risky than holding one stock
Example : Textile
Building optimal portfolio is very difficult
Markowitz Provides an answer for this

5. Assumptions
• The Individual Investor estimates risk on the basis
of Variability of returns ie. the variance of returns
• Investor’s decision is solely based on the expected
return and variance of returns only
• For given level of risk, investor prefers higher
returns to lower return likewise, for a given level of
return investor prefers lower risk than higher risk

6. The Concept
• Markowitz had given up the single stock portfolio and
introduced diversification
• Single security - preferable if expectation of highest return tend
to be real
• In the world of uncertainty, most of the risk averse investors
would like to join Markowitz rather than keeping a single stock
because diversification reduced the risk

8. Thank You