Portfolio Management and the Capital Asset Pricing Model
In this chapter, we explore the issue of risk management in a portfolio of assets. The main issue is how to balance a portfolio, that is, how to choose the percentage (by value) of each asset in the portfolio so as to minimize the overall risk for a given expected return. The first lesson that we will learn is that the risks of each asset in a portfolio alone do not present enough information to understand the overall risk of the entire portfolio. It is necessary that we also consider how the assets interact, as measured by the covariance (or equivalently the correlation) of the individual risks.
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