Homogeneous Expectations

AAA

DEFINITION of 'Homogeneous Expectations'

An assumption in Markowitz Portfolio Theory that all investors will have the same expectations and make the same choices given a particular set of circumstances. The assumption of homogeneous expectations states that all investors will have the same expectations regarding inputs used to develop efficient portfolios, including asset returns, variances and covariances. For example, if shown several investment plans with different returns at a particular risk, investors will choose the plan that boasts the highest return. Similarly, if investors are shown plans that have different risks but the same returns, investors will choose the plan that has the lowest risk.

BREAKING DOWN 'Homogeneous Expectations'

Harry Max Markowitz is an American economist known for his pioneering work in the theory of financial economics, and the publication of his essay "Portfolio Selection" (1952) and his 1959 book, "Portfolio Selection: Efficient Diversification." He was awarded the John von Neumann Theory Prize in 1989 and the Nobel Price in Economics in 1990.

Modern Portfolio Theory (MPT) was pioneered by Markowitz. The theory states that risk-averse investors can develop portfolios that optimize or maximize expected returns based on the particular level of market risk. According to the theory, there are four steps involved in the construction of a portfolio:

1. Security valuation - Describing various assets in terms of expected returns and risks

2. Asset allocation - Distributing various asset classes within the portfolio

3. Portfolio optimization - Reconciling risk and return in the portfolio

4. Performance measurement - Dividing each asset's performance into market-related and industry-related classifications

Markowitz's work altered the way that people invested, emphasizing the importance of investment portfolios, risk and the relationships between securities and diversification. His work has been fundamental to the development of the capital asset pricing model.

Markowitz also described the "efficient frontier," a set of optimal portfolios that provide the best expected returns for a defined risk level or the lowest risk level for a defined expected return. Portfolios that fall outside the efficient frontier are considered sub-optimal because they either carry too much risk relative to the return or too little return relative to the risk.

RELATED TERMS
  1. Efficient Frontier

    A set of optimal portfolios that offers the highest expected ...
  2. Harry Markowitz

    A Nobel Memorial Prize winning economist who devised the modern ...
  3. Portfolio

    A grouping of financial assets such as stocks, bonds and cash ...
  4. Modern Portfolio Theory - MPT

    A theory on how risk-averse investors can construct portfolios ...
  5. Asset Allocation

    An investment strategy that aims to balance risk and reward by ...
  6. Markowitz Efficient Set

    A set of portfolios with returns that are maximized for a given ...
Related Articles
  1. Bonds & Fixed Income

    Find The Highest Returns With The Sharpe Ratio

    Learn how to follow the efficient frontier to increase your chances of successful investing.
  2. Fundamental Analysis

    The Capital Asset Pricing Model: An Overview

    CAPM helps you determine what return you deserve for putting your money at risk.
  3. Insurance

    The Dangers Of Over-Diversifying Your Portfolio

    If you diversify too much, you might not lose much, but you won't gain much either.
  4. Active Trading

    Modern Portfolio Theory: Why It's Still Hip

    See why investors today still follow this old set of principles that reduce risk and increase returns through diversification.
  5. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB Commodity Tracking

    Find out about the PowerShares DB Commodity Tracking ETF, and explore a detailed analysis of the fund that tracks 14 distinct commodities using futures contracts.
  6. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  7. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  8. Mutual Funds & ETFs

    ETF Analysis: Vanguard Small-Cap Value

    Find out about the Vanguard Small-Cap Value ETF, and explore detailed analysis of its characteristics, suitability, recommendations and historical statistics.
  9. Mutual Funds & ETFs

    Top 3 Switzerland ETFs

    Explore detailed analysis and information of the top three Swiss exchange-traded funds that offer exposure to the Swiss equities market.
  10. Savings

    What Women Investors Are Doing Right

    Women's risk aversion, penchant for research – and lack of male-style "irrational exuberance" – means their investing strategies often put them ahead.
RELATED FAQS
  1. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  2. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  3. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  4. What types of assets lower portfolio variance?

    Assets that have a negative correlation with each other reduce portfolio variance. Variance is one measure of the volatility ... Read Full Answer >>
  5. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  6. How does being overweight in a particular sector increase risk to a portfolio?

    An investor who is overweight in a particular sector risks a loss in value for the portfolio if there is a downturn in that ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Stock Market Crash

    A rapid and often unanticipated drop in stock prices. A stock market crash can be the result of major catastrophic events, ...
  2. Financial Crisis

    A situation in which the value of financial institutions or assets drops rapidly. A financial crisis is often associated ...
  3. Election Period

    The period of time during which an investor who owns an extendable or retractable bond must indicate to the issuer whether ...
  4. Shanghai Stock Exchange

    The largest stock exchange in mainland China, the Shanghai Stock Exchange is a nonprofit organization run by the China Securities ...
  5. Dead Cat Bounce

    A temporary recovery from a prolonged decline or bear market, followed by the continuation of the downtrend. A dead cat bounce ...
  6. Bear Market

    A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!