Portfolio Characterisation

Abstract

The basis of investing is the desire to obtain (excess) returns on the investment. This excess return above the risk free rate necessarily implies taking on risk. We therefore need to be able quantify both return and risk on the portfolio level. We have already introduced return and risk in a single-asset context, so we now move on to portfolios of assets. In this chapter we characterise portfolios in terms of return and risk, and we will find that it is a rather more complicated matter than is the case for single assets, particularly with regards to risk. This stems from the fact that asset returns are correlated, and for this reason we need to formally introduce the correlation coefficient to quantify precisely the correlation among the returns on portfolio assets. These coefficients will then enable us to describe the combined returns on the portfolio’s assets, and thereby the risk of the portfolio.