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Portfolio Management Theories on Risk Levels

Portfolio Management Theories on Risk Levels - Case Study Example

Summary

This paper explores portfolio management. Management of portfolios relies upon two theories which are; portfolio theory and capital market theory. The recent upheavals in the financial markets have caused a disturbance in the way these theories of portfolio management are applied…

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Portfolio Management Theories on Risk Levels

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Subject: Management
Type: Case Study
Level: Masters
Pages: 3 (750 words)
Downloads: 2
Author: shane03

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Portfolio management theories are two; portfolio theory and capital market theory. Drake and Fabozzi (2010) define portfolio theory as dealing with the selection of portfolios that maximize expected returns inconsistency with individually acceptable risks. This theory defines expected portfolio returns and acceptable levels of portfolio risk using quantitative models and historical data. Portfolio theory further shows how to construct an optimal portfolio. Brentani (2004) on the other hand defines capital market theory as dealing with the effects of investor decisions on security prices.

This theory shows the relationship that should exist between risk and security returns if investors constructed portfolios as specified by portfolio theory. Markowitz (1952) asserts that the process of selecting portfolios is divided into two stages; observation and experience, and beliefs about the future performance of available securities. The impact of the financial crisis disrupted the forecasts on the future performance of available securities as asserted by the portfolio theory. According to Ciro (2012), the financial crisis forced most of the banks and lenders to shut their doors as investments in the stocks markets declined drastically.

This aspect made the application of forecast facet of portfolio theory difficult. King (1966) basing his argument on the 1930’s financial meltdown and the random-walk theory, claims that this upheaval has seen stock prices move together. Portfolio theory assumes that investors will choose investments that have the lowest amount of risks whenever they are presented with the same level of expected returns.

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