Question

Explain the Two-Fund Separation Theorem and discuss possible explanations to why it is barely supported by empirical evidence. References and citations are needed to support your arguments. Your answer must not exceed 300 words and you must note your word count at the end of your answer. Tables/diagrams/references/direct quotes/footnotes and the reference list are excluded from the word count. (30 marks)

Answer 1

The two-fund separation theory is a focal outcome in current portfolio hypothesis spearheaded by Henry Markowitz . It reveals to us that the hazard return pair of any permissible or possible portfolio can't lie over the capital market line in the hazard return space, acquired

by consolidating the hazard free resource and the portfolio that expands the Sharpe ratio. A significant ramifications is that a financial specialist can isolate her advantage distribution choice into two stages: First, discover the arrangement of unsafe resources that amplifies the SR; at that point, settle on the blend of the ideal hazardous portfolio and the hazard free resource, contingent upon her frame of mind toward chance. W. Sharpe and Lintner determine the ramifications of the two-support detachment property at balance costs, which is known as the capital asset pricing model (CAPM).

The two-step resource allotment procedure depends on the presumption that there is no model vulnerability or model mis-particular, i.e., the info information or parameters are splendidly known. These information parameters are regularly experimentally evaluated from verifiable information of advantage returns, or from broad examination of different kinds of data about the benefits and full scale monetary conditions.

The major Empirical evidences to prove the two fund separation theory  as a better method than CAPM. Two proficient assets or portfolios can be built up with the goal that any productive portfolio can be copied, as far as mean and difference, as a mix of these two. All financial specialists looking for effective portfolios need just put resources into blends of these two reserves.

A rudimentary confirmation of the two-finance detachment hypothesis is given indicating that benefit request may become unclear if the restricting incline of the financial specialist's apathy bends is limited. Besides, it is demonstrated that an extra restricting condition on the hazard avoidance is commonly important to ensure presence of a harmony in the Capital resource evaluating model with one hazard free resource.

References

V. Bawa, S. Brown, and R. Klein.(1979) Estimation Risk and Optimal Portfolio Choice, volume 3 of Studies in Bayesian Econometrics Bell Laboratories Series. Elsevier, New York: North Holland.

J. Berk. (1997)Necessary conditions for the CAPM. Journal of Economic Theory, 73(1):245– 257.

M. Best and P. Grauer(1991) On the sensitivity of mean-variance-efficient portfolios to changes in asset means: Some analytical and computational results. Review of Financial Studies, 4(2):315–342.