In T-B model about ASSET ALLOCATION ON PORTFOLIOS

CFA Level II
#1

in T-B model, when we determine the asset allocation between “mispriced active-portfolio” and “the market portfolio”, does this CAL have a higher slope than the market portfolio’s sharpe ratio? I remember the market porfolio(ie S&P 500) has the highest sharp ratio, right? Pls clarify since I’m a little bit lost…

#2

That’s the entire objective of the TB model, higher return per unit of risk. So yes, the if you draw the CAL it would be steeper than the CML.

#3

bp so your mean “normally” the S&P 500 has the highest sharpe ratio, but in T-B model we found the mispriced assets so our new portfolio structured would be better than the market portfolio?

#4

Having a slope steeper than the market portfolio is usually the sign of a ‘good’ manager. So if the manager is successful his sharpe ratio will be higher than the market.

#5

Remember though that the CML assumes that the market is in equilibrium; the TB model assumes that the active portfolio consists of securities that are mispriced, so therefore is not in equilibrium. When you combine the active portfolio (which is not in equilibrium) withe the passive (market) portfolio (which is assumed to be in equilibrium) you are able to create a CAL with a higher Sharpe than the CML.