PORTFOLIO SELECTION *

PORTFOLIO SELECTION * T he process of selecting a portfolio may be divided into two stages. The first stage starts with observation and experience and ends with beliefs about the future performances of available securities. The second stage starts with the relevant beliefs about future performances and ends with the choice of portfolio. This paper is concerned with the second stage. We first consider the rule that the investor does (or should) maximize discounted expected, or anticipated, returns. This rule is rejected both as a hypothesis to explain, and as a maximum to guide investment behavior. We next consider the rule that the investor does (or should) consider expected return a desirable thing and variance of return an undesirable thing. This rule has many sound points, both as a maxim for, and hypothesis about, investment behavior. We illustrate geometrically relations between beliefs and choice of portfolio according to the “expected returns—variance of returns” rule. One type of rule concerning choice of portfolio is that the investor does (or should) maximize the discounted (or capitalized) value of future returns. Since the future is not known with certainty, it must be “expected” or “anticipated” returns which we discount. Variations of this type of http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

PORTFOLIO SELECTION *

The Journal of Finance, Volume 7 (1) – Mar 1, 1952

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Publisher
Wiley
Copyright
1952 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
D.O.I.
10.1111/j.1540-6261.1952.tb01525.x
Publisher site
See Article on Publisher Site

Abstract

T he process of selecting a portfolio may be divided into two stages. The first stage starts with observation and experience and ends with beliefs about the future performances of available securities. The second stage starts with the relevant beliefs about future performances and ends with the choice of portfolio. This paper is concerned with the second stage. We first consider the rule that the investor does (or should) maximize discounted expected, or anticipated, returns. This rule is rejected both as a hypothesis to explain, and as a maximum to guide investment behavior. We next consider the rule that the investor does (or should) consider expected return a desirable thing and variance of return an undesirable thing. This rule has many sound points, both as a maxim for, and hypothesis about, investment behavior. We illustrate geometrically relations between beliefs and choice of portfolio according to the “expected returns—variance of returns” rule. One type of rule concerning choice of portfolio is that the investor does (or should) maximize the discounted (or capitalized) value of future returns. Since the future is not known with certainty, it must be “expected” or “anticipated” returns which we discount. Variations of this type of

Journal

The Journal of FinanceWiley

Published: Mar 1, 1952

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