Portfolio Theory and Asset Pricing Models
Table of Contents
- Introduction
- Modern Portfolio Theory (MPT)
- Capital Asset Pricing Model (CAPM)
- Arbitrage Pricing Theory (APT)
- Portfolio Optimization
- Summary
Introduction
Welcome to the seventh course in our series on quantitative finance and investment. In this course, we delve into portfolio theory, asset pricing models, and their applications in investment decision-making.
Modern Portfolio Theory (MPT)
MPT, developed by Harry Markowitz, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It’s a foundational theory in finance that informs the construction of optimal investment portfolios.
Capital Asset Pricing Model (CAPM)
The CAPM is a model that determines a theoretically appropriate required rate of return of an asset, given that asset’s systematic, non-diversifiable risk. The model shows that the expected return of a financial asset is linearly related to its beta, which measures the asset’s exposure to systematic risk.
Arbitrage Pricing Theory (APT)
APT is a multi-factor asset pricing model, an alternative to the CAPM. It assumes that an asset’s returns can be predicted using the linear relationship between the asset’s expected return and a number of macroeconomic variables.
Portfolio Optimization
Portfolio optimization involves the best possible allocation of assets to maximize returns and minimize risk. Techniques involve mean-variance optimization, Monte Carlo simulation, and others. We’ll explore these techniques and how they align with MPT.
Summary
This course delved into portfolio theory, asset pricing models, and their applications in investment decision-making. We covered Modern Portfolio Theory, the Capital Asset Pricing Model, and the Arbitrage Pricing Theory, all of which are crucial for understanding how financial assets are priced and how to construct optimal investment portfolios.
Stay tuned for our next course: Risk Management in Finance!