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Passive versus Active Portfolio Management PowerPoint PPT Presentation

Passive versus Active Portfolio Management Review of Market Efficiency Anomalies Market Timing A theoretical model of active portfolio management (Treynor-Black) Quantitative Investment Management Passive Management Buy and Hold Indexation

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Passive versus Active Portfolio Management

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Passive versus Active Portfolio Management

  • Review of Market Efficiency

  • Anomalies

  • Market Timing

  • A theoretical model of active portfolio management (Treynor-Black)

  • Quantitative Investment Management


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Passive Management

  • Buy and Hold

  • Indexation

  • Active management must beat these strategies on a net risk adjusted return basis!

  • What if markets are efficient?


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Treynor-Black Model

  • Suppose you can identify securities that you expect to outperform (or underperform) on a risk-adjusted basis

  • How do you exploit this model?


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Treynor-Black Model: Assumptions

  • Analysts can only produce quality analysis on a small number of securities

  • There is a passive market portfolio (M)

  • Forecasts of return (E(rM) and risk (s) exist

  • Determine abnormal return (a) for analyzed securities

  • Find optimal weights of analyzed securities to create active component (A)

  • Combine A, M and risk-free asset to achieve efficiency


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Treynor-Black: Construction (Step 1)

  • Assume: ri = rf + bi(rM - rf) + ei

  • For analyzed security k: rk = rf + bk(rM - rf) + ek + ak=> estimate ak, bk, s2(ek)

  • To construct A:wk = (ak/s2(ek))/(S[ai/s2(ei)]) => determine aA, bA, s2(eA)


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Treynor-Black: Construction (Step 2)

  • w0 = (aA/s2(eA))/[(E(rM)-rf)/s2M]

  • w* = w0/(1+(1-A)w0)

  • w0 is the proportion of A in the new, enhanced market portfolio (M‘)


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