Portfolio management

Lecturer: Prof. Jens Jackwerth

Monday, 11.45 – 13.15, F425

Teaching Assistant: Manuel Leininger

Group A: Tuesday, 15:15 – 16:45, fortnightly starting 14.11.23, G304
Group B: Thursday, 11:45 – 13:15, fortnightly starting 16.11.23, L829

Ilias Course

Helpful and worth knowing

I would like to suggest to attend the lecture "English for Economist" or the other courses at the Sprachlehrinstitut.

As prerequisite, students should have taken the course Capital Market Theory or equivalent.

Content

This course is an introductory course in Portfolio Management. This course provides an introduction to the basic economic concepts of financial economics; as such, it is intended to be a “first” course in the subject. Economic concepts will always be developed with intuitive reasoning. Many will be formally proven mathematically, and typically in the simplest mathematical context possible. Many will also be illustrated by algebraic or numerical examples.

To provide a clear context for the concepts to be developed, some institutional background is provided at the beginning of the course related to the specifics of various traded securities (currencies, fixed income securities, equities and derivatives) and their markets. A particular interest will be on hedge funds.

Each concept will be developed first in its simplest meaningful economic context. A distinction will be made between concepts that can be understood even in an economy where the future is known with certainty (one state), and those that only become interesting if the role of uncertainty (many states) is considered. Similarly, a distinction will be made between concepts that do and do not require decision making over time (two dates vs many dates). The most basic results will be derived from the twin assumptions of “no riskless arbitrage opportunities” and “perfect markets”. Other results, will in addition require “agent rationality,” “competitive markets,” and “complete markets.” The most detailed results will require specific assumptions describing agent preferences or beliefs.

The basic concepts developed in this course include: stochastic processes of returns, risk-neutral vs subjective probabilities, the stochastic discount factor, necessary and sufficient conditions for existence and uniqueness of risk-neutral probabilities, dynamic completeness, state prices, life-cycle financial planning, determinants of consumption and portfolio choice, portfolio separation and the market portfolio, complete forward vs sequential markets, practical limits to arbitrage, expected utility and risk aversion, alphas and betas, required alphas, market timing vs selectivity, Sharpe ratio, indirect utility functions, continuous rebalancing strategies, and rational expectations.

Models include: standard finance model (two-date model, many dates model, many states model), random walk model, single and multiple factor models, arbitrage pricing theory, mean-variance portfolio choice and mean-variance equilibrium expected returns, constant relative risk aversion-lognormal returns multi-period equilibrium model.

The course ends with a lengthy consideration of one of the key assumptions underlying many of the earlier results: investor rationality. Here it considers the relatively recent challenge from behavioral financial economics and the corresponding rationalist response. New concepts are introduced including minimal vs maximal market rationality, market consensus probabilities, equilibrium sharing rules and a large number of behavioral biases in human decision making.

Books and Reading

In my Semesterapparat you can find amongst others the following books:

"Investments", William Sharpe/Gordon Alexander/Jeffery Bailey. 7th Edition, 2012, Prentice-Hall.
(indicated chapters below correspond very roughly to the subjects covered in the outline; chapters 12, 18, 22 and 24 are not assigned below, but should be read as well).

"Option-Implied Risk-Neutral Distributions and Risk Aversion", Jens Carsten Jackwerth. ISBN 0-943205-66-2, Research Foundation of AIMR, Charlotteville, USA. The monograph can be downloaded through CFA Institute/Publications

"Numerical recipes: the art of scientific computing", William H Press/Saul A Teukolsky/William T Vetterling/Brian P Flannery. 3rd edition, September 2007.

Some other useful books are: Reading the "Wall Street Journal Guide to Understanding Money and Investment" is a painless way of learning about financial market institutions (although somewhat specific to the US). There are a number of fairly interesting "bedtime reading" paperbacks, e.g. "Barbarians at the Gate", "Liar's Poker", and "A Random Walk Down Wall Street", which give some insight into aspects of the financial world.

A good economics dictionary is:
"Wirtschaftswörterbuch German-English; English-German", Wilhelm Schäfer. The price per book is 39.00 EUR - the price for the complete edition is 78.00 EUR.

A good online dictionary is Leo.

Assessment

Assessment will be based on the final exam. Here you can find old Portfolio Management exams: Old Exams/Portfolio Management. The final examination of the course covers the material from weeks 1-15, including. Questions will be in English. Answers can be given in English or German. One A4-sheet, double-sided, is allowed with notes, as well as a non-programmable calculator. Duration of the exam: 90 minutes. Good luck!!!

Odds and Ends

I will provide the lecture notes as pdf-files on the internet.

The range of prior knowledge within the class is wide. Those who have already had exposure to this material should be patient, particularly during the first two weeks covering the basic tools of financial appraisal. Because of the technical nature of some of the material, it is important for you to keep up with the class by working exercises. The practice questions are designed to help those who have not seen this material before to absorb and understand the techniques. Also, you should try the quizzes and other problems at the end of each chapter in the text. It is also essential to do the preparation ahead of time.

For a handheld calculator, you are not allowed programmable calculators. I would use the cheapest Casio-FX, e.g. the Casio FX-82SX for EUR 10. More expensive ones have more complicated functions, which we do not need. You can also get the more expensive HP 10bII+ financial calculator (EUR 40), but it will not help on the exam any more than the Casio.

I will give you further "rules of the game" once we meet in October.
In the meantime
I am looking forward to seeing you in the fall.
all the best,

Jens Jackwerth