To reiterate some of the assumptions that Ellie mentioned earlier plus a few more. These misleading assumptions have been proven wrong so they weaken the theory. * Assumptions: * All investors act rationally and are risk-averse.
Proven wrong by behavioural economists. * Investors all have access to the same sources of information for investment decisions
False because market is asymmetrical with information – due to insider trading and some investors are more informed than others. Many online publications charge members to access their sites, such as The Wall Street Journal or Bloomberg. So investors who don’t pay the additional fee are not as informed. * Investors base decisions solely on expected return and risk (derived from historical returns).
The drawback is that optimal asset allocations are highly sensitive to small changes in inputs, especially expected returns. Portfolios may not be well diversified. * Investors can borrow and lend at a risk-free rate.
The drawback is that borrowing rates are always higher than lending rates. Certain investors are restricted from purchasing securities on margin. * Investors can buy securities of any size.
False as some securities have minimum order sizes. And securities cannot be bought or sold in fractions. Also, each investor has a credit limit so they cannot lend or borrow unlimited amounts of shares. * Single-period perspective.
Investors rarely have a single-period perspective in determining their asset allocation. * Constant returns to scale and infinitely divisible projects.
Not guaranteed, may not occur every time. In reality, most projects cannot always be divided as demanded by the optimum results. * Expected values calculated based on past performance to measure correlation between return and risk.
Not a guarantee of future performance. Leaves out current situations that were not available at the time of collection of the old scenarios. * Ignores various other types of risk.
The definition of risk in the theory is limited to price volatility. It ignores any potential social or environmental risks that investment may have, just focuses on financial risk. EX: BANKRUPTCY * Risk measurement is probabilistic, not structural.
Tells about the likelihood of losses, but not the reasons or explanations why or how it works.