Explanation:
In a mean-variance framework, all investors must have the same calculation for mean, standard deviation, and correlation. It is the mean and the standard deviation that investors are most interested in, and not systematic risk exposure. They are assumed to have access to borrow at the risk-free rate. This approach also needs observations to be distributed normally. Most individual stocks are not normally distributed. They typically have some element of skew, which provides fatter tails.
(Book 4, Module 47.1, LO 47.a)
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Question 10
A risk manager is considering the merits of using a mean-variance framework for investing. The manager knows that there are some limitations. Which of the following statements regarding this investment approach is correct?
A
This framework is customizable to each investor because the mean and standard deviation can be unique for each investor.
B
Systematic risk exposure is considered to be the most important risk factor.
C
Individual stocks typically have a normal distribution, which works well for a mean-variance framework.
D
All investors are assumed to have access to borrowing at the risk-free rate.
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