Concept explainers
To select: The advantages and disadvantages of indexed model over Markowitz model.
Introduction: An investor may invest in various stocks to reduce the risk of losses. Such a theory is called correlation theory. It is believed that an investor takes a lot of risk to achieve higher returns on their investment portfolio.
Explanation of Solution
Advantage of indexed model over Markowitz model:
Markowitz model requires vastly used number of estimates. These estimates can lead to many errors in estimation while implementing the procedure. This is not a part of indexed model.
Disadvantage of indexed model:
As per the assumption of indexed model, the return residuals are not correlated. Now, this assumption would be incorrect if the index used in estimation omits a significant risk factor.
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