Optimization of investment risk using the instigator of its diversification

Abstract

In the early 1950’s, G. Markowitz laid the foundations for the science of effective investment, the so-called portfolio theory. Markovitz’s approach to portfolio selection implies that the investor is trying to solve two problems: maximize expected returns at a given risk level and minimize uncertainty (risk) at a given level of expected returns. The consequence of the existence of two contradictory goals is the need for diversification through the purchase of not one but several securities. The main work on the development of «model of averages and dispersions» was presented by G.Markovits in the article, and later in the monograph. The idea of a generalization of the Markovitz model in the case of risk-free lending and borrowing belongs to J. Tobin. Further generalizations were provided by W. Sharpe, including, for example, the Capital Asset Pricing Model (CAPM). The Markowitz approach implies that the investor has some initial capital (Co) for an investment for a certain period. From all available portfolios, the optimal one is that which corresponds to the point of contact of the investor’s indifference curve to an effective set. At the end of the period of ownership of the portfolio, the initial investor’s capital either increases or decreases depending on the rate of return on the portfolio. Capital created as a result of investing (Ct) may be either fully reinvested or fully spent on consumption, or partially reinvested and partially consumed. Markovitsa’s approach implies that the assets considered for investments are separately risky, that is, each of the N risky assets gives indefinite income for the period of ownership. Since none of the assets has an absolutely negative correlation with any other asset, all portfolios also make indefinite earnings over the ownership period and, therefore, are risky. Until a certain time, the investment analysis was focused on quantitative factors. In fact, if the whole situation could be described with the help of quantitative indicators, then the work could be completed by studying the sensitivity by choosing those investment projects that provide the best quantitative indicators. Unfortunately, the figures cannot explain everything. Figures allow you to see the benefits of the project only in black and white. With the help of qualitative factors you can notice another «fifty shades of gray».