Efficient frontier a holding the correlation coefficient constant we could change the weights of the two assets in the portfolio We could then determine a number of expected risk and return coordinates for the portfolio and plot these in risk-return space It is possible to derive a complete curve by Simply varying the weights by small increments
Efficient Frontier ◼ Holding the correlation coefficient constant, we could change the weights of the two assets in the portfolio. ◼ We could then determine a number of expected risk and return coordinates for the portfolio and plot these in risk-return space. ◼ It is possible to derive a complete curve by simply varying the weights by small increments
Efficient frontier We could examine a number of two-asset portfolios and derive their curves by changing the weights of the assets From these the efficient frontier is derived The efficient frontier is the envelope curve of all of the individual curves
Efficient Frontier ◼ We could examine a number of two-asset portfolios and derive their curves by changing the weights of the assets. ◼ From these the efficient frontier is derived. ◼ The efficient frontier is the envelope curve of all of the individual curves
Efficient frontier a Consists of only those portfolios of risky assets that give the highest possible return for a given level of risk a Dominance principle Each investor will try to hold a portfolio on the efficient frontier a Personal preference Will determine where on the frontier
Efficient Frontier ◼ Consists of only those portfolios of risky assets that give the highest possible return for a given level of risk. ◼ Dominance principle. ◼ Each investor will try to hold a portfolio on the efficient frontier. ◼ Personal preference will determine where on the frontier
Indifference curves Show the investor' s trade-off between risk and return a The steeper the slope, the more risk averse the investor The higher the indifference curve, the greater the utility
Indifference Curves ◼ Show the investor’s trade-off between risk and return. ◼ The steeper the slope, the more risk averse the investor. ◼ The higher the indifference curve, the greater the utility
Efficient frontier and investor Utility All points along the efficient frontier are potentially optimal a Portfolio selection depends on risk tolerance An investor will choose the portfolio that is tangent to the highest attainable indifference curve
Efficient Frontier and Investor Utility ◼ All points along the efficient frontier are potentially optimal. ◼ Portfolio selection depends on risk tolerance. ◼ An investor will choose the portfolio that is tangent to the highest attainable indifference curve