Portfolio Risk and Return: Part I

How investors trade off risk and return: the historical record of the major asset classes and their other characteristics, risk aversion and the utility function, indifference curves and the capital allocation line, the risk of two-asset and many-asset portfolios, diversification through low correlation, the minimum-variance and efficient frontiers, and how each investor's optimal portfolio is chosen.

1. 1. Asset classes: return, risk and other characteristicsOver long periods, asset classes with more risk have earned more return, but mean and variance alone miss skewness, fat tails and trading costs.Free13 min
2. 2. Risk aversion and utilityA utility function turns each investor's attitude to risk into one number per investment, so investments can be ranked: $U = E(r) - \tfrac{1}{2}A\sigma^2$.Video · 7 min13 min
3. 3. Indifference curves and the capital allocation lineIndifference curves show what an investor wants, the capital allocation line shows what is available, and the optimal portfolio is where the two just touch.Video · 7 min14 min
4. 4. Measuring asset and portfolio riskPortfolio return is a weighted average, but portfolio risk depends on weights, individual risks and how the assets move together.Video · 7 min14 min
5. 5. Correlation and the power of diversificationCombining assets that are less than perfectly correlated cuts risk without cutting expected return, and in large portfolios average covariance is what remains.Video · 7 min14 min
6. 6. Integrated cases: a foreign bond with currency, and pairs from a scenario tableTwo exam set-ups in one place: a portfolio whose third 'asset' is a currency, and a scenario table in which the pair that diversifies best can be spotted before any formula is used.16 min
7. 7. Minimum-variance and efficient frontiersOf all the portfolios risky assets can form, only those on the upper half of the minimum-variance frontier, the efficient frontier, are worth holding.Video · 7 min12 min
8. 8. Optimal risky portfolio and the optimal investor portfolioAdding a risk-free asset turns portfolio choice into two steps: everyone picks the same optimal risky portfolio, then each investor chooses how much to lend or borrow.Video · 7 min14 min