What Is "Homogeneous Expectations"?

"Homogeneous expectations" refers to the assumption, expressed in Harry Markowitz's 澳洲幸运5官方开奖结果体彩网:Modern Portfolio Theory (MPT), that all investors have the sa൩me expectations and m🏅ake the same choices in a given situation.

Understanding Homogeneous Expectations

MPT, pioneered by Harry Markowitz in his 1952 paper "Portfolio Selection," is a Nobel prize award-winning theory. It is an investment model designed to maximize returns while taking the lowest possible risk—MPT assumes that all investors are 澳洲幸运5官方开奖结果体彩网:risk-averse and that risk is an inherent part of higher reward.

Markowitz argued that the solution is constructing a portfolio of multiple assets. When assets considered to be high-risk, such as small-cap stocks, are placed alongside others, their澳洲幸运5官方开奖结果体彩网: risk profile changes, balancing everything out because each 澳洲幸运5官方开奖结果体彩网:asset class acts differently during a 澳洲幸运5官方开奖结果体彩网:market cycle.

According to the theory, th🐻ere are four steps involved in the construction of a portfolio:

1. Security 澳洲幸运5官方开奖结果体彩网:valuation: Describing various assets in terms of expected returns and risks
2. 澳洲幸运5官方开奖结果体彩网:Asset allocation: Distributing various asset classes within the portfolio
3. Portfolio 澳洲幸运5官方开奖结果体彩网:optimization: Reconciling risk and return in the portfolio
4. Performance measurement: Dividing each asset's performance into market-related and industry-related classifications.

Homogeneous expectations are a core principle of MPT. It basically assumes all investors have the same expectations regarding inputs used to develop 澳洲幸运5官方开奖结果体彩网:efficient portfolios, including asset returns, 澳洲幸运5官方开奖结果体彩网:variances, and 澳洲幸运5官方开奖结果体彩网:covariances. 

According to homogeneous expectations, if investors are shown several investment plans with different returns at a particular ris๊k, they will choose the plan that boasts the highest return. Alternatively, if investors are shown plans that have different risks but the same returns, they will choose the plan that has the lowest risk. 

As you can see here, the homogeneous expectations assumption works on the theory that investors are rational actors. They all think alike and are not influenced by anything but the facts of the matter at hand. This is also an underlying assumption of many 澳洲幸运5官方开奖结果体彩网:classical economic theories.

Advantages of Homogeneous Expectations

Markowitz’s MPT and homogeneous expectations theory have revolutionized investing strategies, emphasizing the importance of investment portfolios, risk, and the relationships between securities and 澳洲幸运5官方开奖结果体彩网:diversification.

Many investors avoid attempting to 澳洲幸运5官方开奖结果体彩网:time the market, preferring instead to buy securities and then hold onto them over the long-term, known as the 澳洲幸运5官方开奖结果体彩网:buy and hold strategy. The balanced asset allocation approach, championed for Markowitz, has he🐬lped guide them to build robust portfolios.꧙

Criticism of Homogeneous Expectations

MPT has also attr🌸acted plenty of backlashes. Making assumptions is always dangerous and homogeneous expectations make plenty of them.

The theory posits that markets are always 澳洲幸运5官方开奖结果体彩网:efficient and that investors all think alike. Studies in 澳洲幸运5官方开奖结果体彩网:behavioral finance have questioned that premise, arguing that people an꧅d investors are not always rational and have different perceptions and goals that impact their thought processes.

MPT categorizes investors as the same, suggesting that all of them want to maximize returns without taking on unnecessary risk, understand expected returns, do not factor in 澳洲幸运5官方开奖结果体彩网:commissions when m𓄧aking decisions, and have access to the same information. History has shown that this is not always the case, questioning the validity of MPT and its core tenet: the notion of homogeneous expectations.