Finc5001

Abstract

The Mean-Variance approach analysis and the Capital Asset Pricing Model (CAPM) which is fundamentally based on the mean variance approach have been considered as the two significant pillars in the finance analysis field associated with estimating future expected return on stocks. There are numbers of academic literatures focusing on comparing and contrasting these two approaches and trying to find which one is the best estimation instrument. By pursuing this objective, in this paper, we will take a close examine on Mean-Variance approach and CAPM analysis by gathering stock information for a five-year period with monthly frequency from BHP Billiton and Commonwealth Bank Australia. In order to justify which method is more appropriate estimation instrument on future return, the first part of paper will lay out the statistic results on the portfolio combination will be analyzed based on the question provided by the instruction, following by comparing and contrasting the assumptions and implications towards two approaches. Consequently, although imperfections do exist, in general, the individual investors will be benefited by Mean-Variance approach, while CAPM is more suitable for large corporations to forecast the future return.

Question 1 Mean-Variance Approach

Part A

The Mean-Variance approach can be described as, in general, at a given return on risky assets and volatility on the payoffs, an optimal portfolio can be produced for individual investors to achieve the higher return with the minimum risk (Markowitz 1952). Before starting the calculation, it is important to determine following two issues regarding to expected return estimation for our selected stocks: what the data frequency and time period we should use as well as the price index selection.

Length of the data selection

In order to effectively evaluate the estimation results produced by two approaches, the same data interval should be employed for analysis due to consistency....