Markovitzs Mean Variance Combination Model
Harry Markowitz, the founder of modern portfolio theory, developed the Mean Variance combination model. His research states that investors choose their portfolios so they receive the highest expected return while also taking the least amount of risk. The model attempts to explain the behavior of rational investors, and to provide a way to determine the optimal combination of investments available in order to achieve maximum returns.
The model begins by calculating the expected rate of return and risk level for each asset in a given portfolio. The returns are calculated as the expected return multiplied by the probability of success. Risk is calculated as the unpredictability of the return. The model then attempts to minimize risk or the uncertainty of the returns. Markowitz came up with a mathematical solution for this optimization problem.
The mean variance combination model is based on the idea that a portfolio should contain a combination of stocks that will not only outperform the market, but will also provide a low-risk strategy for investors. The model requires that the investor choose two assets for the portfolio; one to reduce risk and one to maximize return. The assets chosen should be as independent from one another as possible. The model assumes that each asset has its own expected rate of return, its own expected risk level, and that there is a certain degree of correlation between the assets (i.e. they will both move in the same direction).
The goal of the mean-variance model is to optimize the portfolio in order to maximize the expected return while minimizing the risk. To do this, it uses a mathematical equation called quadratic programming. It attempts to find the optimal allocations of each asset in the portfolio in order to achieve the desired risk/return tradeoff.
The portfolio is then constructed by blending the assets in varying degrees based on their expected returns and risks. The resulting portfolio consists of a combination of different assets with different weights allocated to each one. The weights are determined by the expected return, expected risk, and correlation of the different assets.
Markowitzs Mean-Variance Model has been used for many years as a tool to analyze financial investments. By taking into account the expected return, risk, and correlation of different investments, investors can optimize their portfolios to achieve maximum expected return while minimizing risk. This model is still widely used today and is often considered to be the most basic, yet effective, form of modern portfolio theory.
