Portfolios - EDHEC-Risk

Giving Up Smartly – MSR
• How to penalize low volatility stocks based on economic theory?
• Theory unambiguously confirms the existence of a positive
risk/return relationship:
– Systematic risk is rewarded (APT);
– Specific risk is also rewarded (Merton (1987));
– Total volatility (model-free) should therefore be rewarded;
– Higher moment risk is also rewarded (many references).
• This justifies the use of the risk-return relationship to build
efficient portfolios: magic of diversification is about mixing highrisk-and-therefore-high-return
stocks so as to generate low risk
portfolios through a smart use of correlations.
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