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.

INVESTOPEDIA EXPLAINS '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. Modern Portfolio Theory - MPT

    A theory on how risk-averse investors can construct portfolios ...
  2. Portfolio

    A grouping of financial assets such as stocks, bonds and cash ...
  3. Harry Markowitz

    A Nobel Memorial Prize winning economist who devised the modern ...
  4. Markowitz Efficient Set

    A set of portfolios with returns that are maximized for a given ...
  5. Efficient Frontier

    A set of optimal portfolios that offers the highest expected ...
  6. Asset Allocation

    An investment strategy that aims to balance risk and reward by ...
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. Trading Strategies

    What is the logic behind using Bollinger BandsĀ® as an indicator of volatility?

    Discover the logic behind using Bollinger Bands as a measure of price volatility for a security, and how the bands adapt to changing price ranges.
  6. Technical Indicators

    Are Bollinger BandsĀ® useful for analyzing securities with very low volatility?

    Learn more about Bollinger Bands, a tool based on standard deviations of moving average that can be applied to both high and low volatility stocks.
  7. Charts & Patterns

    What are the best ways to protect trade positions against false signals?

    Find out why it is important that traders learn to protect themselves against false signals, and read about some of the most common protection strategies.
  8. Chart Advisor

    Invest In Leisure & Entertainment For 2015

    The leisure and entertainment industries are showing strong upward trends as seen in the Powershares Dynamic Leisure & Entertainment ETF.
  9. A Monte Carlo simulation allows analysts and advisors to convert investment chances into choices. The advantage of Monte Carlo is its ability to factor in a range of values for various inputs.
    Fundamental Analysis

    What Can The Monte Carlo Simulation Do For Your Portfolio?

    A Monte Carlo simulation allows analysts and advisors to convert investment chances into choices. The advantage of Monte Carlo is its ability to factor in a range of values for various inputs.
  10. Mutual Funds & ETFs

    What does a mutual fund's beta coefficient measure?

    Evaluate the risk associated with a particular mutual fund by determining its beta coefficient, which illustrates the fund's volatility versus the market.

You May Also Like

Hot Definitions
  1. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  2. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
  3. Special Administrative Region - SAR

    Unique geographical areas with a high degree of autonomy set up by the People's Republic of China. The Special Administrative ...
  4. Annual Percentage Rate - APR

    The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents ...
  5. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
  6. Law Of Supply And Demand

    A theory explaining the interaction between the supply of a resource and the demand for that resource. The law of supply ...
Trading Center