Asset allocation across risky and risk free portfolios
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Asset Allocation across risky and risk-free portfolios. Riccardo Colacito. Allocating Capital Between Risky & Risk-Free Assets. Possible to split investment funds between safe and risky assets Risk free asset: T-bills Risky asset: stock (or a portfolio). Example. r f = 7%. s f = 0%.

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Allocating capital between risky risk free assets
Allocating Capital Between Risky & Risk-Free Assets

  • Possible to split investment funds between safe and risky assets

  • Risk free asset: T-bills

  • Risky asset: stock (or a portfolio)


Example
Example

rf = 7%

sf = 0%

E(rp) = 15%

sp = 22%

y = % in p

(1-y) = % in f





One additional caveat

Can we borrow from a bank at the same rate at which we lend it money?

How does it affect the CAL?

One additional caveat

Lending rate

Borrowing rate



Risk aversion and allocation
Risk Aversion and Allocation Borrowing and Lending Rates

  • Greater levels of risk aversion lead to larger proportions of the risk free rate

  • Lower levels of risk aversion lead to larger proportions of the portfolio of risky assets

  • Willingness to accept high levels of risk for high levels of returns would result in leveraged combinations


Open question
Open question Borrowing and Lending Rates

  • How can we estimate expected returns and standard deviations?

    • Use historical data

    • Use survey data


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