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Portfolio Optimization –
Finding the Efficient Frontier
Theory, and
a Practical Example
Stodder, Efficient Frontier
correlation coefficient
• The correlation coefficient represents the
direction and strength of the relationship
between two assets, and it takes on a value
between –1 and 1. The signs of the
correlation
coefficient indicate the direction of the
relationship
Stodder, Efficient Frontier
Efficient Frontier
Efficient Frontier
The Efficient Frontier
Non-Diversifiable
Risk
Required Return
40%
Optimal
Portfolios
30%
Efficient
Frontier
20%
Market Portforlio
10%
σ -- Standard Deviation of Stock
0%
10%
20%
30%
Stodder, Efficient Frontier
Efficient Frontier
Basic Strategy:
• Find the Standard Deviation (σi) and
Mean Return (μi) of every stock Stock i.
• For any given rate of return, find the
minimal standard deviation portfolio that
can achieve that return.
Run Simulation
• From Financial Models Using
Simulation and Optimization
by Wayne Winston:
Ch. 16, “Portfolio Optimization”
Stodder, Efficient Frontier
Stodder, Efficient Frontier
Stodder, Efficient Frontier
Stodder, Efficient Frontier
Stodder, Efficient Frontier
Stodder, Efficient Frontier
Stodder, Efficient Frontier
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