Abstract
This chapter presents the modern portfolio theory from the theoretical perspective. It is demonstrated how investors may choose the optimal portfolio out of different sets of portfolios, considering risk and return characteristics. This chapter introduces the primary relationship between the rate of return and risk with the first well-known model of market equilibrium: the capital asset pricing model (CAPM). Furthermore, the chapter discusses potential benefits derived from international diversification and the idea of regional diversification. The main aim of the chapter is to provide knowledge of the portfolio theory to help investors cope with this demanding task.
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Notes
- 1.
There is a distinction between the single-index model and the market model. The market model is identical to the single-index model except the assumption that cov(ei,ej) = 0 is not made.
- 2.
Read more: Dębski et al. (2018, pp. 5–16).
- 3.
- 4.
For example, labor strike or technological breakthrough.
- 5.
More formally, the covariance between portfolio’s return and the variance of market portfolio return.
- 6.
The offset mechanism does not work.
- 7.
Investment per se means buying and selling currencies.
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Miziołek, T., Feder-Sempach, E., Zaremba, A. (2020). Portfolio Theory and International Diversification. In: International Equity Exchange-Traded Funds. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-53864-4_2
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DOI: https://doi.org/10.1007/978-3-030-53864-4_2
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