Summary
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Extract
The information content of equity option spread series and the assessment of investor risk appetite.
1. INTRODUCTION
Modern portfolio theory has frequently been interpreted by investment professionals as a justification for encouraging their clients to pursue buy-and-hold investment strategies. While the diversification aspects of modern portfolio theory are solidly grounded in statistical theory, the implication that the creation of a well-diversified portfolio will enable an investor to successfully hold that portfolio for extended periods of time has been shown over the last decade to be, at best, highly questionable. The presumption that past equity market performance will necessarily eventually be replicated conveniently minimizes the catastrophic consequences associated with the lengthy time horizon that may be necessary for the replication to occur. Simply stated, many would rationally consider 10 years to be the "long run". The consequences associated with the inevitable severe market downturns have too often been ignored. Investment advisors typically attempt to assess the risk tolerance of their clients so as to provide their clients with some degree of comfort with the portfolios they hold. These assessments may involve a determination of the proportions of their portfolios that they wish to have allocated to various asset classes. Within the equity class, for example, a beta comfort level may be established. The greater the accuracy of this beta comfort level estimate, the more likely clients are to be comfortable with the outcomes of their equity allocations. Within the equity asset class, greater precision in estimating the risk tolerance ...See the full content of this document
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