Professional Documents
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I. Introduction
V. Conclusions
2
I. Index Management
A. Motivation: You want to follow a passive portfolio strategy,
but, you do not want to hold the market portfolio because of
transaction costs. So, what should you do?
• Construct a portfolio that mimics as closely as possible the
market portfolio.
D. Performance Enhancement
1. We have presented considerable evidence that traditional in-
dicies are inefficient.
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20 30 40 50 60 70 80 90 100
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20 30 40 50 60 70 80 90 100
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20 30 40 50 60 70 80 90 100
Active and Passive Portfolio Management 9
• Assuming that you believe that the foreign income factor will
rise by 2%, the expected return on this portfolio is:
2 · 0.12 − 5.5 · 0.12 + 4.5 · 0.12 + 10 · 0.02 = 0.32
0.12 Assets
Minimum Var Frontier
CML
0.11 MVE Portfolio C
E−MVE Combinations
Expected Return
0.1 B
0.09
Market Portfolio
A
0.08
E
0.07
0.06 D
0.1 0.12 0.14 0.16 0.18 0.2 0.22 0.24 0.26 0.28
Return Standard Deviation
16
where
αA
ARA = .
σ2(eA )
• ARA is called the Appraisal Ratio of portfolio A
5. Again, these equations are just an shortcut for the full analy-
sis we did earlier.