Efficient Frontier - Optimal Portfolio Selection

STEP 1

E(ROR)

SD

12%

10%

18%

15%

STEP 2

0.3

CORR(B,S)

STEP 3

RORf

Weight B

Weight S

100.00%

SD

E(ROR)

0.00%

10.00%

12.00%

95.00%

5.00%

9.75%

12.30%

90.00%

10.00%

9.56%

12.60%

85.00%

15.00%

9.42%

12.90%

80.00%

20.00%

9.35%

13.20%

75.00%

25.00%

9.34%

13.50%

70.00%

30.00%

9.39%

13.80%

65.00%

35.00%

9.50%

14.10%

60.00%

40.00%

9.67%

14.40%

55.00%

45.00%

9.90%

14.70%

50.00%

50.00%

10.19%

15.00%

45.00%

55.00%

10.52%

15.30%

40.00%

60.00%

10.89%

15.60%

35.00%

65.00%

11.30%

15.90%

30.00%

70.00%

11.75%

16.20%

25.00%

75.00%

12.23%

16.50%

20.00%

80.00%

12.74%

16.80%

15.00%

85.00%

13.28%

17.10%

10.00%

90.00%

13.83%

17.40%

5.00%

95.00%

14.41%

17.70%

0.00%

100.00%

15.00%

18.00%

STEP 4

EFFICIENT FRONTIER WITH TWO RISKY ASSETS

20.00%

E(ROR)

18.00%
16.00%
14.00%
12.00%
B

10.00%
8.00%
8.00%

9.00%

10.00%

11.00%

12.00%

13.00%

14.00%

8.00%
8.00%

9.00%

10.00%

11.00%
SD

12.00%

13.00%

STEP 5 Tangent Portfolio T

STEP 6

Weight in B

52.94%

Weight in S

47.06%

SD(T)

E(ROR)T
10.01%

Weight B

14.82%
Weight S

SD

E(ROR)

STEP 7

with risk-free
E(ROR)

100.00%

0.00%

10.00%

12.00%

14.81%

95.00%

5.00%

9.75%

12.30%

14.54%

90.00%

10.00%

9.56%

12.60%

14.33%

85.00%

15.00%

9.42%

12.90%

14.18%

80.00%

20.00%

9.35%

13.20%

14.10%

75.00%

25.00%

9.34%

13.50%

14.09%

70.00%

30.00%

9.39%

13.80%

14.15%

65.00%

35.00%

9.50%

14.10%

14.27%

60.00%

40.00%

9.67%

14.40%

14.46%

55.00%

45.00%

9.90%

14.70%

14.70%

50.00%

50.00%

10.19%

15.00%

15.01%

45.00%

55.00%

10.52%

15.30%

15.37%

40.00%

60.00%

10.89%

15.60%

15.77%

35.00%

65.00%

11.30%

15.90%

16.22%

30.00%

70.00%

11.75%

16.20%

16.70%

25.00%

75.00%

12.23%

16.50%

17.22%

20.00%

80.00%

12.74%

16.80%

17.77%

15.00%

85.00%

13.28%

17.10%

18.35%

10.00%

90.00%

13.83%

17.40%

18.95%

5.00%

95.00%

14.41%

17.70%

19.57%

0.00%

100.00%

15.00%

18.00%

20.21%

Rf
Graph:
Step 8

EFFICIENT FRONTIER WITH RISK-FREE ASSET

21.00%
19.00%

E(ROR)

17.00%
15.00%
13.00%
11.00%
9.00%
7.00%

14.00%

7.00%
5.00%
8.00%

9.00%

10.00%

11.00%

12.00%

13.00%

14.00%

SD

STEP 9 Optimal portfolio using T and F

Risk aversion

Weight in T

Weight in F

E(ROR)

SD

parameter A:
1

-8.09%

108.09%

3.12%

0.81%

45.96%

54.04%

8.97%

4.60%

63.97%

36.03%

10.92%

6.41%

72.98%

27.02%

11.90%

7.31%

78.38%

21.62%

12.48%

7.85%

81.99%

18.01%

12.87%

8.21%

84.56%

15.44%

13.15%

8.47%

86.49%

13.51%

13.36%

8.66%

87.99%

12.01%

13.52%

8.81%

E(ROR) =
12.48%
STEP 10 I choose a
My corresponding coefficient of risk aversion A is:
My corresponding utility level is:
STEP 11

SD

E(ROR)

0.00%

10.94%

1.00%

10.97%

2.00%

11.04%

3.00%

11.17%

4.00%

11.34%

5.00%

11.57%

6.00%

11.84%

7.00%

12.17%

8.00%

12.54%

9.00%

12.97%

10.00%

13.44%

11.00%

13.97%

12.00%

14.54%

13.00%

15.17%

14.00%

15.84%

15.00%

16.57%

16.00%

17.34%

17.00%

18.17%

18.00%

19.04%

19.00%

19.97%

20.00%

20.94%

and

SD=

5
0.1094

Step 12
INDIFFERENCE CURVE
22.00%

E(ROR)

20.00%
18.00%
16.00%
14.00%
12.00%
10.00%
0.00%

5.00%

10.00%

15.00%

20.00%

SD

STEP 13

Weight B

Weight S

SD

E(ROR)

with risk-free

risky only
E(ROR)
100.00%

0.00%

10.00%

12.00%

14.81%

95.00%

5.00%

9.75%

12.30%

14.54%

90.00%

10.00%

9.56%

12.60%

14.33%

85.00%

15.00%

9.42%

12.90%

14.18%

80.00%

20.00%

9.35%

13.20%

14.10%

75.00%

25.00%

9.34%

13.50%

14.09%

70.00%

30.00%

9.39%

13.80%

14.15%

65.00%

35.00%

9.50%

14.10%

14.27%

60.00%

40.00%

9.67%

14.40%

14.46%

55.00%

45.00%

9.90%

14.70%

14.70%

50.00%

50.00%

10.19%

15.00%

15.01%

45.00%

55.00%

10.52%

15.30%

15.37%

40.00%

60.00%

10.89%

15.60%

15.77%

35.00%

65.00%

11.30%

15.90%

16.22%

30.00%

70.00%

11.75%

16.20%

16.70%

25.00%

75.00%

12.23%

16.50%

17.22%

20.00%

80.00%

12.74%

16.80%

17.77%

15.00%

85.00%

13.28%

17.10%

18.35%

10.00%

90.00%

13.83%

17.40%

18.95%

5.00%

95.00%

14.41%

17.70%

19.57%

0.00%

100.00%

15.00%

18.00%

20.21%

Step 14

Efficient Frontier and Portfolio Choice

22.00%
20.00%

E(ROR)

18.00%

E(ROR)

18.00%
E(ROR) risky only

16.00%

with risk-free E(ROR)

14.00%

Indiff. curve E(ROR)

12.00%
10.00%
9.00%

10.00%

11.00%

12.00%

13.00%

14.00%
SD

15.00%

16.00%

4%

14.00%

15.00%

16.00%

14.00%

15.00%

16.00%

15.00%

16.00%

Optimal Utility
0.0312
0.0876
0.1031
0.1083
0.1094
0.1085
0.1064
0.1036
0.1003
7.85%

20.00%

25.00%

Indiff. curve
E(ROR)
13.44%
13.32%
13.23%
13.16%
13.13%
13.12%
13.15%
13.20%
13.28%
13.40%
13.54%
13.71%
13.91%
14.14%
14.40%
14.69%
15.00%
15.35%
15.73%
16.13%
16.57%

E(ROR) risky only

with risk-free E(ROR)
Indiff. curve E(ROR)