Portfolio Risk: In the eyes of institutional portfolio managers

If you stand at road crossing facing two options, right or left, what makes you hesitate about the decision? Is it perhaps the uncertainty of what the future holds for each option? One can never be sure of the future and this uncertainty can be seen as risk. According to Magnusson (2005), risk within the economical sense is when the economical outcome depends solely or partly on uncertain factors. Everyday investments, such as personal savings plans, have people think about and decide what risk level that is appropriate, dependent on for example the risk profile of the investor and the length of the investment. At a bank you are often faced with the option to start saving in a bank account with limited risk and with a low interest rate or start saving in mutual funds with larger risk but also historically better returns. The fundamental concept of risk and return is that the riskier an investment seams to be, the higher the expected return it should generate (Damodaran, 2002).


Humans have to constantly consider risk- and return tradeoffs.  It becomes interesting for all investors to understand if and how portfolio risk is utilized and looked upon through the eyes of the mangers in charge over our savings. Do their view of risk and return translate to available theories and is the theoretically popular and much criticized beta measure used at all in practice.

Purpose: The purpose of this master thesis is to describe and analyze how institutional investors apply the concepts of risk in portfolio management, to illustrate how they work with risk variables in practice and if risk is closely linked to return.


1 Introduction
1.1 Background
1.2 Problem Discussion
1.3 Purpose
1.4 Perspective
1.5 Delimitations
1.6 Methodological Approach
1.7 Methodological Overview
1.8 Literature Study
2 Theoretical Framework
2.1 Portfolio Theory
2.2 What is Really Risk?
2.3 Risk Aversion
2.4 The Central Model Within Portfolio Theory – CAPM
2.4.1 Beta
2.4.2 Empirical results of CAPM and beta
2.4.3 Arguments against CAPM and beta
2.5 Alternatives to Beta
2.5.1 Arbitrage Pricing Theory
2.5.2 Value at Risk
2.5.3 Tracking error
2.5.4 BAPM & behavioral beta
2.5.5 Other risk models
2.6 The Role of Risk Variables in Valuation Models
2.7 Risk Management
2.7.1 Hedging
2.7.2 Diversification
2.8 Return
3 Method
3.1 Qualitative Research Approach
3.2 Primary and Secondary Data
3.3 Qualitative Interview Techniques
3.4 Sample Selection
3.5 Structure of the Questionnaire
3.6 Analysis of Collected Data
3.7 Reliability and Validity
3.8 Presentation of the Participants
4 Empirical Findings & Analysis
4.1 Risk Definition
4.2 The Risk Variables Used and Why
4.3 The View on Beta as a Risk Measure
4.4 Risk Measures’ Accuracy on Explaining the Level of Risk
4.5 The Major Flaws in the Existing Risk Measures
4.6 The Importance and Effort Devoted at Risk Management
4.7 The Connection Between Risk and Return
5 Conclusion and Final Remarks
5.1 Conclusion
5.2 Authors’ Reflections
5.3 Criticism of Method Used
5.4 Suggestions for Further Studies
Reference List
Appendix A
Appendix B
Appendix C

Author: Sellgren, Jakob,Karlström, Rickard

Source: Jönköping University

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