Market Portfolio
Contents
Unlocking the Concept of Market Portfolio: A Comprehensive Guide
Understanding Market Portfolio
A market portfolio represents a theoretical amalgamation of all available assets within the investment universe, meticulously weighted according to their presence in the market. It mirrors the market's expected return and serves as a benchmark for gauging investment performance.
The Basics of Market Portfolio
Distinguished by its comprehensive diversification, a market portfolio is primarily exposed to systematic risk, devoid of the idiosyncratic risks associated with individual assets. Through a simple illustration, the composition of a market portfolio underscores the proportional representation of various assets based on their market capitalization.
The Market Portfolio in the Capital Asset Pricing Model
Integral to the capital asset pricing model (CAPM), the market portfolio facilitates asset pricing by delineating an asset's anticipated return relative to its systematic risk. The CAPM equation, encapsulating the expected return, risk-free rate, beta, and market portfolio return, elucidates the interplay between risk and return.
Limitations of a Market Portfolio
Economist Richard Roll's seminal critique challenges the feasibility of achieving true diversification through a market portfolio, positing that its composition would necessitate the inclusion of every asset worldwide. This skepticism underscores the inherent limitations of crafting a fully diversified market portfolio.
Real World Example of a Market Portfolio
Examining the historical returns of a global multi-asset portfolio spanning from 1960 to 2017 offers insights into its performance dynamics. Real compounded returns, contingent upon currency fluctuations, underscore the variability inherent in market portfolio investments.