Introduction Debt Policy

The core of the theory was pioneered by Markowitz’s (1956) article (the theory is 55 years old)

Although there are no securities with perfectly negative correlation, almost all assets are less than perfectly correlated. Therefore, you can reduce total risk (p) through diversification. If we consider many assets at various weights, we can generate the efficient frontier.

Among the above three estimates, estimates of correlation are an entirely different matter. Why?

Where can the information come from?

1. Data on financial performance (estimation)

2. From analysts (whose job is to understand assets)

Security analysts are typically organized into market sectors such as oil, electronics, retailers

One (analyst) follows one (industry line).

This structure can inform about individual variances or correlation within one sector but not co-variances or correlations between sectors

So there is a problem of implementation

Among the above three estimates, estimates of correlation are an entirely different matter. Why?

Where can the information come from?

1. Data on financial performance (estimation)

2. From analysts (whose job is to understand assets)

Security analysts are typically organized into market sectors such as oil, electronics, retailers

One (analyst) follows one (industry line).

This structure can inform about individual variances or correlation within one sector but not co-variances or correlations between sectors

So there is a problem of implementationBetas Tend Toward One (1)

Blume’s analysis on the behavior of betas over time shows that there is a tendency of actual betas in the forecast period to move closer to one than the estimated betas from historical data. (Table 7.4)

Betas in the forecast period tend to be closer to one (1) than the estimate obtained from historical data

Blume’s method measured directly the adjustment towards one (1) from a given historical series