Homogeneous Expectations

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.



comments powered by Disqus
Hot Definitions
  1. Oil Reserves

    An estimate of the amount of crude oil located in a particular economic region. Oil reserves must have the potential of being extracted under current technological constraints. For example, if oil pools are located at unattainable depths, they would not be considered part of the nation's reserves.
  2. Joint Venture - JV

    A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it.
  3. Aggregate Risk

    The exposure of a bank, financial institution, or any type of major investor to foreign exchange contracts - both spot and forward - from a single counterparty or client. Aggregate risk in forex may also be defined as the total exposure of an entity to changes or fluctuations in currency rates.
  4. Organic Growth

    The growth rate that a company can achieve by increasing output and enhancing sales. This excludes any profits or growth acquired from takeovers, acquisitions or mergers. Takeovers, acquisitions and mergers do not bring about profits generated within the company, and are therefore not considered organic.
  5. Family Limited Partnership - FLP

    A type of partnership designed to centralize family business or investment accounts. FLPs pool together a family's assets into one single family-owned business partnership that family members own shares of. FLPs are frequently used as an estate tax minimization strategy, as shares in the FLP can be transferred between generations, at lower taxation rates than would be applied to the partnership's holdings.
  6. Yield Burning

    The illegal practice of underwriters marking up the prices on bonds for the purpose of reducing the yield on the bond. This practice, referred to as "burning the yield," is done after the bond is placed in escrow for an investor who is awaiting repayment.
Trading Center