Portfolio Analysis in the Crosshairs

Murguia, Alejandro; Phil, M.; Umemoto, Dean T.
November 2002
Journal of Financial Planning;Nov2002, Vol. 15 Issue 11, p74
Academic Journal
This article presents a three-factor model as a tool that can be used by financial planners to structure and analyze investments. If all investors are able to combine a market portfolio of all risky assets with a risk-free asset, the only risk that an investor would be compensated for is investing in the market as opposed to the risk-free asset. Hence, investors get paid for taking risk associated with the market. Furthermore, the capital asset pricing model (CAPM) posits that the expected return of any risky asset is a function of its relationship with the market portfolio. As of November 2002, the CAPM is the backbone of modern portfolio theory. It is commonly used in practical research and included in financial Web sites and software packages used for analyzing mutual funds and portfolios. But academic research has shown that other risk factors play a significant role in stock market equity returns. The statistical test for using the three-factor model requires knowledge of multiple regression analysis. The method for conducting this type of analysis is presented in many introductory statistical textbooks. As an investment advisor, it can be difficult to arrive at an effective set of recommendations for a prospective client whose portfolio consists of multiple accounts with a varied menu of equity and fixed-income holdings.


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