book 1 exam 3pm - treynor black

“The treynor black model is based on having a limited number of securities in the actively managed portfolio” schweser says true. in theory, if there was enough mispricing, couldn’t the combination of the active/mkt portfolio be entirely composed of mispriced securities, in a large number so as to diversify unsystematic risk? appreciate your perspective on this…

when markets are not in equilibrium, there are a limited number of securities with extremely high magnitute alphas. these should be part of the activley managed portfolio. as equilibrium gets closer, the magnitude of the alphas derease reducing the number of securities in the active portfolio 1luv

dirtydirty Wrote: ------------------------------------------------------- > “The treynor black model is based on having a > limited number of securities in the actively > managed portfolio” > > schweser says true. > > in theory, if there was enough mispricing, > couldn’t the combination of the active/mkt > portfolio be entirely composed of mispriced > securities, in a large number so as to diversify > unsystematic risk? > > appreciate your perspective on this… No, important thing you need to remember is the fact that alphas are due to unsystematic risk component of the security. So if you keep on adding securities with postivie or negative alphas u r adding unsystematic componenet to the portfolio not reducing it. Market portfolio is added to the active portfolio for diversification purpose as they don’t have unsystematic component.

at some point with enough unsystematics in there, wouldnt they start to cancel each other out?

i suppose that i am missing the intent of the question… thanks guys

dirtydirty Wrote: ------------------------------------------------------- > i suppose that i am missing the intent of the > question… thanks guys The theory behind TB is that the markets are pretty much in equilibrium with only a few mispriced securities. As an analyst you need to find the limited amount of mispriced securities and put them in your active portfolio.

dirtydirty Wrote: ------------------------------------------------------- > at some point with enough unsystematics in there, > wouldnt they start to cancel each other out? I think my understanding was wrong wrt unsystematic risk in active portfolio. Read schweser pg 295 (book 3) for explanation on what will happen if the number of mispriced securities is large.

According to the curriculum I believe, only a small number of securities are mispriced. Furthermore, Treynor-Black calls for an optimal mix between the market portfolio and the active portfolio.