Michael,
You are not alone in criticizing statistical model for distinguishing between upside reward and downside risk. However, if equity price changes are indeed random (and may be they are not, as contemporary research shows), the two are symmetric and hence statistically speaking both are valid measures of risk as the estimated value may differ from the actual value only by a constant factor. Try any books of statistics for the proof.
As for whether the market embodies an acceptable level of risk, MPT doesn't say it does! Acceptable levels are determined by individual situations. MPT only advocates adjusting returns by risk for comparative analysis. If the fund manager assumed the same level of risk as the market and got a better return, that's superior performance! If the investor doesn't consider a negative return as an acceptable level of risk, (s)he can invest in a different fund.
As for your portfolios, what if in the 90/10 portfolio you lose 10% in options? Do you stick to t-bills from that point on? If you do, you do not have a chance of beating the market. If you don't, then your downside risk is more than 10%. If you claim that you can never lose 100% of the options portion, you are making an assumption like those who claim that the market always goes up in the long run. That is a categorically wrong assumption in a mathematical sense while calculating risk.
As for the remaining two portfolios, again, my question to you is: how do you rate their riskiness relative to the market? Provide an objective numeric estimate if you please.
-BGR. |
