Professor, I'm a big fan and am sincerely grateful for your dedication and generosity in providing these. However, I found this session to be confusing. Up to around 9:35 we're provided an explanation for why diversification provides benefits by lowering the overall risk in our portfolio. Then it moves quickly into the role of the marginal investor and their ability to influence prices. But the linkage between the benefits I get from diversifying my portfolio and the role of the marginal investor and their ability to set prices, isn't made clear. We then move on to how this special class of price setting, diversified marginal investor thinks about risk, and how including a new stock *adds* risk to their portfolio, when we were previously told adding an additional company to our portfolio lowers risk. Immediately after this we get into the CAPM, further adding to the confusion, for example, at 13:11 "Now when I ask you how risky a stock is, Disney or Tesla... I'm going to measure that risk by the risk it adds to the market portfolio," having been told previously, that adding a new stock to a portfolio lowers overall risk. I think this session may try to cover too much ground, too quickly, IMHO.
There are leaps made and I could have taken more care to explain each one. The message that I was trying to convey is that in public market, the measurement and pricing of risk is set by the marginal investors, and if they are diversified, the only risk that will get priced in is the risk you cannot diversify away. Thus, if you are an investor who chooses not to be diversified, you will start off at a disadvantage, since much of the risk that you chose to expose yourself to will not be rewarded by the market. You may be such a good stock picker that you make up for this disadvantage, but that is tough mountain to climb.
@@AswathDamodaranonValuation Thank you sir, I think I'm getting closer. Does the following make sense? 1. Through my eyes as a small investor, the benefit from adding one additional stock (e.g., ABC Corp.) to my portfolio is reduced overall risk because I’m spreading out my firm-specific risk across a greater number of companies. This benefit can be quantified statistically through the formula shown. 2. Large investors that trade shares have another perspective. Through their market power they can demand adequate compensation for the risk they take for investing in the company. In this way these large, stock-trading investors influence the price of risk (i.e., compensation) that ABC Corp. must pay to attract them. 3. ABC Corp. has a different perspective. They’re not overly concerned with small investors because they don’t have much influence on the company’s share price or provide large amounts of capital. Large investors that trade their shares, however, have the power to influence the share price by buying or selling large blocks of shares. This is important because share price is a key performance metric for company executives and because big investors provide large amounts of capital. Therefore ABC Corp. must price risk adequately to attract these large investors. 4. ABC Corp. pays the same price for risk (compensation) regardless of the size of the investor, or whether investors' portfolios are diversified or not. It's up to large and small investors themselves to determine how much company-specific risk to diversify away. The maximally diversified portfolio (lowest risk) would contain every tradeable asset on the planet (i.e., the market portfolio).
Hello Professor! Do you think it's better to account for Risk in the Discounting Rate or is it better to keep the Discounting Rate fairly constant and account for Risk in the Cashflow assumptions (Like you do in most of your Valuations and come up with various scenarios for the assumptions)? Thank you.
so in terms of index funds, the mechanical challenge increases way more than individual stocks. Would it be ideal to have different funds in different asset classes to further build on the benefits of diversification?
Hi @AswathDamodaranonValuation, How did we come up with that formula for calculating the combined risk. Why is it not simply W1L1 + W2L2 - (1-Corr)(L1L2). So I'm just trying to understand why is this the formula in the way it is. I'm thinking this is based on the binomial series. Can you please confirm?
Use Var(x+y). It has nothing to do with the binomial. Bionomial only works for independent events btw - thats not the case here. The correlation is above zero.
Hi Aswath Sir Good morning from India . Great content but after the discussion of marginal investor I was lost . Can you please help to further explain it .
@@MaartenvanRossemLezingen Not sure if you're a troll but can anyone explain why having a LOWER standard deviation is better than having a higher standard deviation? I don't understand the meaning of standard deviation very well at all, but what little I do think I understand contradicts that entirely, you'd want standard deviation to be as high as possible...... As I understand standard deviation, Standard Deviation 1 being high would mean having a high chance of being within that standard deviation (1) which is closest to the median, standard deviation 2 is further from the median, you'd want that to be lower, and standard deviation 3 is furthest from the median, that should be the lowest. That's all I know about it, I don't understand what's in this video at all.
Standard deviation means risk for a security as i have learned in modelling Which is calculated by carrying Standard deviation for change in prices of a commodity (its shows how much it deviates from average )
@@ReddoFreddo Notice how he gave the example of a company who choses to open a new store. Now that store can either perform exceptionally well or exceptionally poor. That spread if its larger, the risk the company takes with it is greater. And thus the deviation from mean will be higher. So having a lower deviation is way better than having a larger one coz that is directly related to the risk involved in the process.
In this case, it might be helpful to think of the volatility of the stock. Recall that the lower the standard deviation is, the more data points are closer to the mean. The opposite is true the higher the standard deviation is. The higher the standard the deviation, the more spread out and unpredictable the data becomes. In relation to stocks then, the higher the standard deviation, the more risky the stock could be.
Always amazed to witness someone articulate so well! Simply in awe of how Prof. Damodaran imparts knowledge.
it took me 3 hours to consume this Masterpeice. Thankyou sir for your services.
Hope I get into Stern and take your Valuation class. Great stuff.
You have the class on youtube lol unless you want the diploma and debt
Seriously, thanks for this. It means the world to me.
You are a legend, thank you so much for the informative video! Quite enjoyed it
Thank you very much, Prof for sharing and generosity. Inspired me. God bless you more.
Such an informative, succinct, and interesting video. Thank you
Professor, I'm a big fan and am sincerely grateful for your dedication and generosity in providing these. However, I found this session to be confusing.
Up to around 9:35 we're provided an explanation for why diversification provides benefits by lowering the overall risk in our portfolio. Then it moves quickly into the role of the marginal investor and their ability to influence prices. But the linkage between the benefits I get from diversifying my portfolio and the role of the marginal investor and their ability to set prices, isn't made clear.
We then move on to how this special class of price setting, diversified marginal investor thinks about risk, and how including a new stock *adds* risk to their portfolio, when we were previously told adding an additional company to our portfolio lowers risk. Immediately after this we get into the CAPM, further adding to the confusion, for example, at 13:11 "Now when I ask you how risky a stock is, Disney or Tesla... I'm going to measure that risk by the risk it adds to the market portfolio," having been told previously, that adding a new stock to a portfolio lowers overall risk.
I think this session may try to cover too much ground, too quickly, IMHO.
There are leaps made and I could have taken more care to explain each one. The message that I was trying to convey is that in public market, the measurement and pricing of risk is set by the marginal investors, and if they are diversified, the only risk that will get priced in is the risk you cannot diversify away. Thus, if you are an investor who chooses not to be diversified, you will start off at a disadvantage, since much of the risk that you chose to expose yourself to will not be rewarded by the market. You may be such a good stock picker that you make up for this disadvantage, but that is tough mountain to climb.
@@AswathDamodaranonValuation Thank you sir, I think I'm getting closer. Does the following make sense?
1. Through my eyes as a small investor, the benefit from adding one additional stock (e.g., ABC Corp.) to my portfolio is reduced overall risk because I’m spreading out my firm-specific risk across a greater number of companies. This benefit can be quantified statistically through the formula shown.
2. Large investors that trade shares have another perspective. Through their market power they can demand adequate compensation for the risk they take for investing in the company. In this way these large, stock-trading investors influence the price of risk (i.e., compensation) that ABC Corp. must pay to attract them.
3. ABC Corp. has a different perspective. They’re not overly concerned with small investors because they don’t have much influence on the company’s share price or provide large amounts of capital. Large investors that trade their shares, however, have the power to influence the share price by buying or selling large blocks of shares. This is important because share price is a key performance metric for company executives and because big investors provide large amounts of capital. Therefore ABC Corp. must price risk adequately to attract these large investors.
4. ABC Corp. pays the same price for risk (compensation) regardless of the size of the investor, or whether investors' portfolios are diversified or not. It's up to large and small investors themselves to determine how much company-specific risk to diversify away. The maximally diversified portfolio (lowest risk) would contain every tradeable asset on the planet (i.e., the market portfolio).
Hello Professor! Do you think it's better to account for Risk in the Discounting Rate or is it better to keep the Discounting Rate fairly constant and account for Risk in the Cashflow assumptions (Like you do in most of your Valuations and come up with various scenarios for the assumptions)? Thank you.
Thank you for the great presentation.
so in terms of index funds, the mechanical challenge increases way more than individual stocks. Would it be ideal to have different funds in different asset classes to further build on the benefits of diversification?
Hi @AswathDamodaranonValuation,
How did we come up with that formula for calculating the combined risk. Why is it not simply W1L1 + W2L2 - (1-Corr)(L1L2). So I'm just trying to understand why is this the formula in the way it is. I'm thinking this is based on the binomial series. Can you please confirm?
Use Var(x+y). It has nothing to do with the binomial. Bionomial only works for independent events btw - thats not the case here. The correlation is above zero.
Hi Aswath Sir
Good morning from India .
Great content but after the discussion of marginal investor I was lost . Can you please help to further explain it .
Does this still apply for something like commercial real estate, which due to its capital intensive nature is difficult to diversify?
Increasing the total capital investment by way of shared investments ig!
What does the stock having a standard deviation of 10% or 15% mean?
@@MaartenvanRossemLezingen Not sure if you're a troll but can anyone explain why having a LOWER standard deviation is better than having a higher standard deviation? I don't understand the meaning of standard deviation very well at all, but what little I do think I understand contradicts that entirely, you'd want standard deviation to be as high as possible...... As I understand standard deviation, Standard Deviation 1 being high would mean having a high chance of being within that standard deviation (1) which is closest to the median, standard deviation 2 is further from the median, you'd want that to be lower, and standard deviation 3 is furthest from the median, that should be the lowest. That's all I know about it, I don't understand what's in this video at all.
Standard deviation means risk for a security as i have learned in modelling
Which is calculated by carrying Standard deviation for change in prices of a commodity (its shows how much it deviates from average )
@@ReddoFreddo Notice how he gave the example of a company who choses to open a new store. Now that store can either perform exceptionally well or exceptionally poor. That spread if its larger, the risk the company takes with it is greater. And thus the deviation from mean will be higher. So having a lower deviation is way better than having a larger one coz that is directly related to the risk involved in the process.
In this case, it might be helpful to think of the volatility of the stock. Recall that the lower the standard deviation is, the more data points are closer to the mean. The opposite is true the higher the standard deviation is. The higher the standard the deviation, the more spread out and unpredictable the data becomes. In relation to stocks then, the higher the standard deviation, the more risky the stock could be.
I takes time, some writing, googling to properly digest even his small lectures.
Can't believe this gold mine is available for free.
Aswath, Thank you for the videos. really valuable information and I like it. is there a way to make videos more fun though?
Phenomenal!
I hope I can be at least half as good. 😍
I hope i get into stern undergrad, so i can attend your class
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