Portfolio Theory

Portfolio theory is a theory developed by Markowitz (also referred to as portfolio (selection) theory) that substantiates rational decisions in financial investments. It is to be separated from the strategy portfolio (portfolio analyzes) with which long-term product decisions are based on the Product life cycle (Product life cycle concept) and your own market position.
The central message is the diversification effect. If you buy a second security for an existing security, the risk of the total return (measured in price gains and dividends) may be considerably reduced. A simple dice game should be mentioned to illustrate this. The (average) number of points rolled corresponds to the return on a securities portfolio. If you only use one die (= one security), the number of points rolled fluctuate greatly. But if you throw ten at once, then the achieved average result will deviate much less from the expected number of 3.5 = [(1 + 2 + 3 + 4 + 5 + 6): 6]. The player / investor achieves a risk reduction solely through the diversification of the securities exposure and without loss of the expected return.

The intensity of the risk reduction through the diversification when buying securities, ie the diversification effect, depends on the correlation coefficient p. This statistical parameter measures the relationship between price and yield changes of two securities (or portfolios). Due to the way it is calculated, p can only assume values in the interval [1, -1]. If there is a correlation of 1 between two securities, then both always have completely identical price and dividend fluctuations. Diversification is not possible in this case. At p = -1, changes in value run in exactly the opposite direction. Here you can achieve complete security by correctly distributing the investment amount.

Such extreme values will not occur in practice. Nevertheless, significant differences in the diversification options are to be expected. With one ordinary and one preference share of a company, you will hardly achieve risk diversification, while shares of an investment goods company and a consumer-related industrial company will have a significantly low correlation coefficient. p is usually determined from past price data. For the purchase of securities based solely on the investment motive, two important rules of action result from the portfolio theory. First, exposure to securities should be in a wide variety of stocks.
Second, only the expected return and the non-diversifiable risk are decisive for the selection of individual shares. Since the absolute spread of the return values can be reduced considerably through diversification, this should not be a benchmark for an investor to evaluate securities. Only the contribution made to reducing the overall portfolio risk should be rewarded with risk premiums on the accepted course. The key parameter for determining the non-diversifiable risk is the correlation coefficient.

For the long term Financial planning the diversification effect is also of interest. If a stock corporation wants a broad group of shareholders, then the market value of its own paper should sometimes be reduced through capital increases from company funds. This enables even small shareholders to implement attractive diversification.

The Capital Asset Pricing Model (CAPM), as a further development of the portfolio theory, transfers the results of the investment to the investment decision (company valuation), among other things. According to this, an investment is all the more advantageous, the less it is correlated with the investment opportunities of the capital market.

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