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Financial Modeling - Essay Example

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It has been argued that this economic turmoil has rendered portfolio management theories irrelevant. This paper explores this assertion. Recent Upheavals in World Financial Markets The global financial crisis of the 21st century has been described as the greatest economic and financial crisis the world has seen since the Great Depression of the 1930s (Ciro 2012). This economic turmoil, unlike the 1930s depression, caught many by surprise. Governments, investors, and the knowledgeable and sophisticated market participants were caught unawares by the speed and intensity of the economic decline. The international credit and financial markets were disrupted and dislocated by this financial crisis especially in 2008 and 2009. Governments in response to this economic crisis came up with policy and fallout responses from 2009 and 2011. These responses to some extent have rendered portfolio management theories irrelevant. Why Portfolio Management Theories Have Become Irrelevant Portfolio management theories are two; portfolio theory and capital market theory. ...
Brentani (2004) on the other hand defines capital market theory as dealing with the effects of investor decisions on security prices. This theory shows the relationship that should exist between risk and security returns if investors constructed portfolios as specified by portfolio theory. Markowitz (1952) asserts that the process of selecting portfolios is divided into two stages; observation and experience, and beliefs about the future performance of available securities. The impact of the financial crisis disrupted the forecasts on future performance of available securities as asserted by the portfolio theory. According to Ciro (2012), the financial crisis forced most of the banks and lenders to shut their doors as investments in the stocks markets declined drastically. This aspect made the application of forecast facet of portfolio theory difficult. King (1966) basing his argument on the 1930’s financial meltdown and the random-walk theory, claims that this upheaval has seen stock prices move together. Portfolio theory assumes that investors will choose investments that have the lowest amount of risks whenever they are presented with the same level of expected returns. Fama and French (2002) argue that investors will seek to maximize their utility basing the decision to invest on investment’s risk and return. Apparently, the financial slowdown increased the risk levels and as such it was expected that investment rates may fall. This did not happen as expected. According to Amenc and Martellini (2011), this market turbulence has also impacted the wealth levels around the globe negatively and led to doubts about the value added by professional managers by the institutional investors. According to Statman (1987), ...Show more
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