Portfolio theory was put forward by Markowitz, which mainly uses variance to measure risk and describe absolute risk. By diversifying investment, the risk (variance) of portfolio is minimized.
The formula of CPAM is expected rate of return = risk-free rate of return +beta value * (market portfolio rate of return-risk-free rate of return). Using beta value to measure risk means that the fluctuation of asset price relative to the market describes the relative risk.
The application of portfolio theory;
Portfolio theory provides an important ideological basis and a set of analysis system for the construction and analysis of effective portfolio, and its influence on modern investment management practice is mainly manifested in the following four aspects:
1.Markowitz defined two basic concepts of investment management accurately for the first time. Since then, considering risk and return at the same time is regarded as two indispensable elements (parameters) to describe reasonable investment objectives.
Before Markowitz, although investment consultants and fund managers also considered risk factors, they could only pay attention to the return on investment because they could not effectively measure risk. Markowitz uses the expected value (mean) of return on investment to represent the return on investment (rate) and variance (or standard deviation) to represent the risk of return, which solves the problem of measuring the risk of assets. He thinks that typical investors are risk-averse, and they will try their best to avoid risks while pursuing high expected returns. Accordingly, Markowitz put forward a set of portfolio investment theory based on mean one-variance analysis to maximize utility.
2. The explanation of the rationality of diversified investment by portfolio theory provides an important theoretical basis for the existence of fund management industry.
Before markowitz, people had a certain understanding that diversification can reduce risks, but they never formed a systematic understanding in theory.
The variance formula of portfolio shows that the variance of portfolio is not a simple linear combination of the variance of securities in portfolio, but depends on the correlation between securities to a great extent. The return and standard deviation of a single security itself may not be attractive to investors, but if it has little or even negative correlation with the securities in the portfolio, it will be included in the portfolio. When there are a large number of securities in the portfolio, the variance of the portfolio depends more on the covariance between securities to a great extent, and the variance of individual securities will be in a secondary position. Therefore, the variance formula of portfolio not only provides a theoretical explanation for the rationality of diversification, but also provides practical guidance for effective diversification.
3. The concept of "effective portfolio" put forward by 3.Markowitz makes fund managers pay more attention to the construction of effective portfolio from the analysis of individual securities in the past.
Since Markowitz published his famous paper in the early 1950s, investment management has changed from focusing on stock selection to focusing on the relationship between diversified investments and portfolio assets. In fact, portfolio theory has extended the concept of investment management to portfolio management. Therefore, the practice of investment management has undergone revolutionary changes.
4.Markowitz's portfolio theory is widely used in the optimal allocation of main asset types in portfolio, and it has been proved to be effective by practice.