Market-Based Portfolio Variance

Victor Olkhov

Papers from arXiv.org

Abstract: The variance measures the portfolio risks the investors are taking. The investor, who holds his portfolio and doesn't trade his shares, at the current time can use the time series of the market trades that were made during the averaging interval with the securities of his portfolio and assess the current return, variance, and hence the current risks of his portfolio. We show how the time series of trades with the securities of the portfolio determine the time series of trades with the portfolio as a single market security. The time series of trades with the portfolio determine its return and variance in the same form as the time series of trades with securities determine their returns and variances. The description of any portfolio and any single market security is equal. The time series of the portfolio trades define the decomposition of the portfolio variance by its securities, which is a quadratic form in the variables of relative amounts invested into securities. Its coefficients themselves are quadratic forms in the variables of relative numbers of shares of its securities. If one assumes that the volumes of all consecutive deals with each security are constant, the decomposition of the portfolio variance coincides with Markowitz's (1952) variance, which ignores the effects of random trade volumes. The use of the variance that accounts for the randomness of trade volumes could help majors like BlackRock, JP Morgan, and the U.S. Fed to adjust their models, like Aladdin and Azimov, to the reality of random markets.

Date: 2025-04, Revised 2025-07
New Economics Papers: this item is included in nep-fmk
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