Mean Approach & Beta Approach in Stock-Investing
This report aims at implement two distinct approaches, which can indicate the expected return and risk of a two-stock portfolio, to generate a practical solution to risk-analyzing for stock-investing. The two approaches are Mean-Variance Approach and CAPM Approach. While we apply the Mean-Variance Approach to determine the expected return and standard deviation, we employ the CAPM approach to measure the beta and expected return of each stock. The calculations of the aforesaid mathematical characteristics will contain the weekly returns during a seven-year time period integrated with the ASX all ordinaries Accumulation Index as a substitute for the market index and Official Cash Rate (thereafter, OCR, which is the interest …show more content…
In terms of identifying the optimal portfolio, the investor pursues a minimum of risk.
See Appendix A3 for the Graph
On the basis of the Mean-Variance approach, it can be concluded from the graph above that the optimal portfolio is the portfolio No.22, combining 52.5% of DJS and 47.5% of BHP, and generating a mean of 0.525368% and a standard deviation of 4.645503%. No.22 portfolio fulfills a successful diversification for the unsystematic risk. Namely, it provides the lowest risk among all possible portfolios, which meets our request for investment.
3. CAPM Approach
The Capital Asset Pricing Model (CAPM) has been regarded as a simple and potent theory of asset pricing for over 20 years, which is originally presented by Sharpe (1964), Lintner (1965) and J.Mossin (1966) along with the suggestions of mean variance optimization by Markowitz. CAPM indicates that in equilibrium, assets should be priced as that the expected return equals the risk-free rate of interest plus a premium for risk. The premium for risk equals the risk of the asset multiplied by the market risk premium. The assessment of risk in relation to the CAPM is beta--the covariance of the asset’s returns with the market return, standardized by the variance of market returns. Ultimately, Sharp (1964) and others established the CAPM in the expression of formulas below: [pic]=[pic]+[pic][pic] [pic]