Efficient Frontier Analysis
The definition of the efficient frontier says that “the efficient frontier represents the set of portfolios that has the maximum rate of return for every given level of risk, or the minimum risk for every level of return.” I plotted standard deviation on x axes and Returns on y axes to interpret efficient frontier. Exhibits also include these and the graphs you asked for as graph2:
In our study, we concentrated on the optimal portfolios, the one which has the lowest volatility or risk, for given level of return. The area below the frontier shows the achievable risk-return combinations, there will be at least one portfolio constructible that has the risk and return corresponding to that point. No portfolio on the efficient frontier can dominate any other portfolio on the efficient frontier. All of these portfolios have different return and risk measures, with expected rates of return that increase with higher risk. When we increased the expected return incrementally the weight of BBY and MRK increased until expected return is 2 ,MRK decreasing and BBY increasing afterwards ,whereas weight of WMT, C, IBM and HSY decreased respectively and became 0.Weight of HD is always 0 since it has a very low return/risk ratio compared to others. For the highest return of 2.5 BBY and MRK were optimal combinations since they are highly negatively correlated compared to others. Since BBY is on the efficient frontier, the decision to prefer it or other portfolios to each other depends on risk preference of individuals. The other individual securities are not efficient in these cases since they are on the area below the curve. The portfolios that are closest to the efficient frontier are more diversified since the portfolios on the efficient frontier are the most diversified. As you can see in exhibit 7 the minimum variances that you obtained by making up a portfolio of 7 securities are all below the individual standard deviations for the same level of expected return while they are
In our study, we concentrated on the optimal portfolios, the one which has the lowest volatility or risk, for given level of return. The area below the frontier shows the achievable risk-return combinations, there will be at least one portfolio constructible that has the risk and return corresponding to that point. No portfolio on the efficient frontier can dominate any other portfolio on the efficient frontier. All of these portfolios have different return and risk measures, with expected rates of return that increase with higher risk. When we increased the expected return incrementally the weight of BBY and MRK increased until expected return is 2 ,MRK decreasing and BBY increasing afterwards ,whereas weight of WMT, C, IBM and HSY decreased respectively and became 0.Weight of HD is always 0 since it has a very low return/risk ratio compared to others. For the highest return of 2.5 BBY and MRK were optimal combinations since they are highly negatively correlated compared to others. Since BBY is on the efficient frontier, the decision to prefer it or other portfolios to each other depends on risk preference of individuals. The other individual securities are not efficient in these cases since they are on the area below the curve. The portfolios that are closest to the efficient frontier are more diversified since the portfolios on the efficient frontier are the most diversified. As you can see in exhibit 7 the minimum variances that you obtained by making up a portfolio of 7 securities are all below the individual standard deviations for the same level of expected return while they are