Differentiate between the following: 'Markowitz model' and 'Sharpe index model'

Answer 3(b) Markowitz model and Sharpe Index Model Markowitz model Dr. Harry M. Markowitz is credited with developing the first modern portfolio analysis model, the Markowitz Model. It provides a theoretical framework for analysis of risk-return choices. The concept of efficient portfolios has been enunciated in this model. A portfolio is efficient when it yields highest return for a particular level of risk or minimizes risk for a specified level of expected return. The Markowitz model makes the following assumptions regarding investor behaviour: Investors consider each investment alternative as being represented by a probability distribution of expected returns over some holding period. Investors maximize one period expected utility and possess utility curve, which demonstrates diminishing marginal utility of wealth. Individuals estimate risk on the basis of variability of expected returns. Investors base decisions solely on expected return and variance of returns only. At a given risk level, higher returns are preferred to lower returns. Similarly for a given level of expected returns, investors prefer less risk to more risk. Sharpe Index Model Willam Sharpe introduced a model called Sharp Index Model in which return on a security is correlated to an index of securities or an index or an economic indicator like GDP or general price level. Sharpe developed the Single-Index Model and Multi index model. The single-index model imposes restrictions on how security returns can co-vary. In particular, it is assumed that all covariance arises through an 'index.' This leads to a reduction in complexity. Besides simplifying the covariance matrix, this approach is easily extended to take account of non-financial factors. In the multi-index model, for example, one of the indexes could easily be the rate of inflation.