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Efficient Frontier with Nordstrom, Starbucks and Microsoft

Monthly data from 1995 - 1999


0.100
0.090
Efficient Frontier of T-bills and Risky
Assets

0.080

0.070
Tangency

Frontier

Portfolio ER

0.060

Nordstrom
Starbucks

0.050

Microsoft
Global Min

Microsoft

Tangency

0.040

Tan + T-bills

0.030

Starbucks
Efficient Frontier of Risky Assets

0.020
Global min
rf

0.010
Nordstrom
0.000
0.000

0.050

0.100

0.150
Portfolio SD

0.200

0.250

VaR Frontier
$107,500
$107,000
$106,500

Expected Portfolio Gain

$106,000
$105,500
$105,000
$104,500
$104,000
$103,500
$103,000
$102,500
$102,000

$-

$5,000

$10,000

$15,000
5% Portfolio VaR

$20,000

$25,000

Three-firm case: Computing the efficient frontier using Matrix Algebra

mu

Inputs to Markowitz Algorithm


Stock
E[R]
SD(R)
Nordstrom
0.15%
10.55%
Starbucks
2.85%
14.22%
Microsoft
4.27%
10.06%

covmat
VAR(R)=varcov
0.011
0.003
0.003
0.020
0.002
0.001

0.002
0.001
0.010

Computing the Portfolio frontier for the risky assets is a multi-step process (Markowitz algorithm)
Step 1. Find the global minimum variance portfolio, compute its mean and variance
Step 2. Determine an efficent portfolio with target return equal to the largest expected return of the given set of a
mean and variance
Step 3. Compute the covariance between the returns on the global minimum variance portfolio found in step 1 an
the efficient portfolio found in step 2.
Step 4. Compute portfolio frontier using result that any portfolio on the frontier is a convex combination of any tw
portfolios.

Step 2

p1vec
Step 1

gvec

Computing an efficient portfolio using the "solver"


Problem: minimize x'Sx subject to x'1 = 1 and x'm = m0
target
x1
x2
x3
Constraint 1 Constraint 2 Var(Rp)
0.043
-0.091
0.262
0.829
1.000
0.043
0.009
Computing the global minimum variance portfolio using the "solver"
Problem: minimize x'Sx subject to x'1 = 1
x1
x2
x3
Constraint 1
Var(Rp)
0.364
0.194
0.442
1.000
0.005

PORTFOLIO STATISTICS
E[Rp]
VAR(Rp) SD(Rp) Cov(Rp1,Rgmin)
Port 1
0.043
0.009
0.092
0.005
Global min
0.025
0.005
0.073
covp1gmin
mugmin vargmiin
Computing tangency portfolio using the solver

tvec

Tangency

tvec2

T-bill rate
0.01
Problem: maximize Sharpe slope = (x'm - rf)/sqrt(x'Sx) subject to x'1 = 1
x1
x2
x3
Constraint 1
E[Rp] - rf
Var(Rp)
Slope
-0.548
0.330
1.218
1.000
0.051
0.018
0.376
PORTFOLIO STATISTICS
E[Rp]
VAR(Rp) SD(Rp)
0.061
0.018
0.134
mutan
sdtan
Problem: maximize Sharpe slope = (x'm - rf)/sqrt(x'Sx) subject to x'1 = 1 and x(i) >= 0
x1
x2
x3
Constraint 1
E[Rp] - rf
Var(Rp)
Slope
0.000
0.190
0.810
1.000
0.030
0.008
0.342
PORTFOLIO STATISTICS

Tangency

E[Rp]
VAR(Rp) SD(Rp)
0.040
0.008
0.088

Weights in global min var portfolio


1.000

weights

0.800
0.600
0.400
0.200
0.000
-0.200
Nordstrom

Starbucks

Microsoft

assets

Weights

Weights in tangency portfolio


1.400
1.200
1.000
0.800
0.600
0.400
0.200
0.000
-0.200
-0.400
-0.600
-0.800
Nordstrom

Starbucks
Assets

Microsoft

5% Value-at Risk Calculations

W0
$ 100,000

50000000 7071.0678

rkowitz algorithm)

pected return of the given set of assets, compute its

ariance portfolio found in step 1 and the returns on

is a convex combination of any two frontier

Determine Efficient Frontier of Risky Assets Only


xp1
xgmin
E[Rp]
var(Rp)
SD(Rp)
0
1
0.025
0.005
0.073
0.1
0.9
0.027
0.005
0.073
0.2
0.8
0.029
0.005
0.074
0.3
0.7
0.030
0.006
0.075
0.4
0.6
0.032
0.006
0.077
0.5
0.5
0.034
0.006
0.078
0.6
0.4
0.036
0.006
0.081
0.7
0.3
0.037
0.007
0.083
0.8
0.2
0.039
0.007
0.086
0.9
0.1
0.041
0.008
0.089
1
0
0.043
0.009
0.092
1.1
-0.1
0.044
0.009
0.096
1.2
-0.2
0.046
0.010
0.100
1.3
-0.3
0.048
0.011
0.103
1.4
-0.4
0.050
0.012
0.107
1.5
-0.5
0.052
0.012
0.112
1.6
-0.6
0.053
0.013
0.116
1.7
-0.7
0.055
0.014
0.120
1.8
-0.8
0.057
0.016
0.125
1.9
-0.9
0.059
0.017
0.130
2
-1
0.060
0.018
0.134
2.1
-1.1
0.062
0.019
0.139
2.2
-1.2
0.064
0.021
0.144
2.3
-1.3
0.066
0.022
0.149
2.4
-1.4
0.068
0.024
0.154
2.5
-1.5
0.069
0.025
0.158

5% VaR calculations for portfolios


E[W1]
SD(W1)
$ 102,497 $ 7,317
$ 102,674 $ 7,338
$ 102,852 $ 7,403
$ 103,029 $ 7,509
$ 103,207 $ 7,655
$ 103,384 $ 7,839
$ 103,561 $ 8,057
$ 103,739 $ 8,309
$ 103,916 $ 8,589
$ 104,094 $ 8,897
$ 104,271 $ 9,228
$ 104,449 $ 9,581
$ 104,626 $ 9,954
$ 104,803 $ 10,343
$ 104,981 $ 10,748
$ 105,158 $ 11,167
$ 105,336 $ 11,597
$ 105,513 $ 12,039
$ 105,691 $ 12,490
$ 105,868 $ 12,950
$ 106,045 $ 13,418
$ 106,223 $ 13,893
$ 106,400 $ 14,374
$ 106,578 $ 14,861
$ 106,755 $ 15,353
$ 106,933 $ 15,849

Determine Efficient Frontier of Risky Assets and T-bills


xtan
E[Rp]
SD(Rp)
0
0.010
0.000
0.1
0.015
0.013
0.2
0.020
0.027
0.3
0.025
0.040
0.4
0.030
0.054
0.5
0.035
0.067
0.6
0.040
0.081
0.7
0.045
0.094
0.8
0.050
0.108
0.9
0.056
0.121
1
0.061
0.134
1.1
0.066
0.148
1.2
0.071
0.161
1.3
0.076
0.175
1.4
0.081
0.188
1.5
0.086
0.202

lculations for portfolios


q(0.05)
VaR
$ 90,462 $ 9,538
$ 90,604 $ 9,396
$ 90,675 $ 9,325
$ 90,678 $ 9,322
$ 90,616 $ 9,384
$ 90,491 $ 9,509
$ 90,308 $ 9,692
$ 90,072 $ 9,928
$ 89,788 $ 10,212
$ 89,460 $ 10,540
$ 89,092 $ 10,908
$ 88,689 $ 11,311
$ 88,253 $ 11,747
$ 87,790 $ 12,210
$ 87,302 $ 12,698
$ 86,791 $ 13,209
$ 86,260 $ 13,740
$ 85,711 $ 14,289
$ 85,146 $ 14,854
$ 84,567 $ 15,433
$ 83,975 $ 16,025
$ 83,371 $ 16,629
$ 82,757 $ 17,243
$ 82,134 $ 17,866
$ 81,502 $ 18,498
$ 80,863 $ 19,137

Mar-95
Apr-95
May-95
Jun-95
Jul-95
Aug-95
Sep-95
Oct-95
Nov-95
Dec-95
Jan-96
Feb-96
Mar-96
Apr-96
May-96
Jun-96
Jul-96
Aug-96
Sep-96
Oct-96
Nov-96
Dec-96
Jan-97
Feb-97
Mar-97
Apr-97
May-97
Jun-97
Jul-97
Aug-97
Sep-97
Oct-97
Nov-97
Dec-97
Jan-98
Feb-98
Mar-98
Apr-98
May-98
Jun-98
Jul-98
Aug-98
Sep-98
Oct-98
Nov-98
Dec-98
Jan-99
Feb-99
Mar-99
Apr-99
May-99

Nordstrom Starbucks Microsoft


-0.036
0.005
0.121
-0.057
-0.021
0.139
0.078
0.212
0.035
-0.003
0.204
0.065
-0.028
0.048
0.001
0.028
0.068
0.022
0.012
-0.055
-0.022
-0.119
0.036
0.100
0.060
0.074
-0.138
0.031
-0.006
0.007
-0.031
-0.226
0.053
0.142
0.051
0.065
0.071
0.280
0.044
0.049
0.151
0.094
0.005
0.000
0.047
-0.136
0.041
0.012
-0.070
-0.083
-0.019
-0.059
0.231
0.038
-0.026
0.008
0.074
-0.052
-0.015
0.040
0.190
0.063
0.134
-0.205
-0.190
0.052
0.047
0.179
0.211
-0.007
-0.018
-0.045
0.030
-0.127
-0.061
0.036
0.008
0.282
0.204
0.053
0.020
0.022
0.212
0.019
0.144
0.050
0.112
0.034
0.002
-0.067
0.086
0.020
0.001
-0.040
-0.237
-0.018
-0.035
0.055
0.085
0.023
0.096
-0.091
-0.171
-0.048
0.143
0.122
0.079
0.128
0.107
0.136
0.055
0.025
0.060
0.007
0.098
-0.003
-0.061
0.070
0.107
0.245
-0.213
-0.244
0.014
-0.040
-0.283
-0.136
-0.190
0.137
0.137
0.099
0.181
-0.039
0.312
0.061
0.142
-0.071
0.196
0.128
0.182
-0.075
0.233
-0.032
0.015
-0.153
0.015
0.060
0.177
-0.150
0.275
-0.097
0.011
-0.002
-0.008

mean
var
sd

Nordstrom Starbucks Microsoft


0.15%
2.85%
4.27%
1.11%
2.02%
1.01%
10.55%
14.22%
10.06%

Covariance Matrix
Nordstrom Starbucks Microsoft
Nordstrom
0.011
0.003
0.002
Starbucks
0.003
0.020
0.001
Microsoft
0.002
0.001
0.010
Correlation Matrix
Nordstrom Starbucks Microsoft
Nordstrom
1.000
0.176
0.174
Starbucks
0.003
1.000
0.001
Microsoft
0.174
0.079
1.000

Jun-99
Jul-99
Aug-99
Sep-99
Oct-99
Nov-99
Dec-99
Jan-00

-0.058
-0.064
-0.102
-0.047
-0.079
0.112
-0.055
-0.179

0.018
-0.480
-0.016
0.080
0.093
-0.023
-0.091
0.277

0.111
-0.050
0.076
-0.022
0.022
-0.017
0.249
-0.176

Means and variances are computed using


the usual descriptive statistics

The covariance matrix may be quickly computed


using Tools/Data Analysis/Covariance. Use
copy/Paste special/Transpose to fill in
covariance matrix

The correlation matrix may be quickly computed


using Tools/Data Analysis/Correlation. Use
copy/Paste special/Transpose to fill in correlation
matrix