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You are on page 1of 13

Table of correlations

Asset A Asset B Asset C Things in dark grey are input parameters

Asset A 1.0000 0.3694 0.1539 Things in light grey are computed intermediat

Asset B 0.3694 1.0000 0.2148 Things in yellow are labels

Asset C 0.1539 0.2148 1.0000 Things in red are "Solver" inputs or outputs

E(return) Risk

Asset A 20.00% 28.00%

Asset B 18.00% 33.00%

Asset C 33.00% 40.00%

Table of covariances

Asset A Asset B Asset C

Asset A 7.84% 3.41% 1.72%

Asset B 3.41% 10.89% 2.84%

Asset C 1.72% 2.84% 16.00%

Asset A 150.80%

Asset B -111.15%

Asset C 60.34%

Total 1 (this is a CONSTRAINT for "Solver", this cell B23 must be forced to equal one)

(it is the constraint that the total proportions of our wealth must equal one)

This bit is used to find the risk of the portfolio

Asset A Asset B Asset C

Proportion 150.80% -111.15% 60.34% These numbers are a table of, for instance

Asset A 150.80% 17.8294% -5.7210% 1.5685% proportion of A * proportion of B *

Asset B -111.15% -5.7210% 13.4529% -1.9016% covariance of A and B

Asset C 60.34% 1.5685% -1.9016% 5.8260%

30.07% (it you are minimizing risk for a given return you should tell "Solver" that

this cell, B35, is fixed--at whatever level of return you want. If you are maximizing

return for a fixed risk, you should tell "Solver" to maximize this cell

50.00% (if you are minimizing risk for a given return you should tell "Solver" to minimize

this cell, B40. If you are maximizing return for a fixed risk you should

tell "Solver" that this cell is fixed.)

Now use "solver" to either minimize the risk for a given return

(ie minimize B37 for a prescribed value of B35) or

maximize return for a given risk (ie, maximize B35 for a given

value of B37).

In both cases B23 should be constrained to equal 1, this is the

Page 1

ef

Page 2

ef

grey are computed intermediate things

w are labels

re "Solver" inputs or outputs

alth must equal one)

* proportion of B *

want. If you are maximizing

mize this cell

isk you should

Page 3

Table of correlations

Asset A Asset B Asset C Things in dark grey are input parameters

Asset A 100.00% 36.94% 15.39% Things in light grey are computed intermediat

Asset B 36.94% 100.00% 21.48% Things in yellow are labels

Asset C 15.39% 21.48% 100.00% Things in red are "Solver" inputs or outputs

E(return) Risk

Asset A 20.00% 28.00%

Asset B 18.00% 33.00%

Asset C 33.00% 40.00%

Asset A Asset B Asset C Construct covariance matrix using formulae

Asset A 7.8400% 3.4133% 1.7237% such as covar(A,B)=risk(A)*risk(B)*correl(A,B)

Asset B 3.4133% 10.8900% 2.8354%

Asset C 1.7237% 2.8354% 16.0000%

Asset A 0.4261 Normally these values are set by "Solver" but it may be necessary to

Asset B 0.0953 reset them to "sensible" values and then re-run "Solver" if "Solver"

Asset C 0.4785 fails to find a solution (eg, B23=1/3, B24=1/3, B25=1/3 )

Total 1.0000 (this is a CONSTRAINT for "Solver", this cell B23 must be forced to equal one)

(it is the constraint that the sum of the proportions of our wealth must equal one)

This bit is used to find the risk of the portfolio of purely risky assets

Asset A Asset B Asset C

Proportion 42.61% 9.53% 47.85% These numbers are a table of, for instance

Asset A 42.61% 1.4237% 0.1386% 0.3515% proportion of A * proportion of B *

Asset B 9.53% 0.1386% 0.0989% 0.1293% covariance of A and B

Asset C 47.85% 0.3515% 0.1293% 3.6640%

26.03%

25.35%

0.79019019

To find the Market Price of Risk (and hence the Capital Market Line)

use "solver" to maximize cell B44 subject to the constraint that

cell B26 is equal to one.

You access "solver" from the "Tools" menu.

grey are input parameters

grey are computed intermediate things

w are labels

re "Solver" inputs or outputs

A,B)=risk(A)*risk(B)*correl(A,B)

re-run "Solver" if "Solver"

=1/3, B25=1/3 )

be forced to equal one)

our wealth must equal one)

* proportion of B *

results

You have to either maximize the return given a level of risk (this is best for large risks and returns)

or minimize the risk for a given level of return (this is best for small risks and returns)

for a lot of possible levels of risk and return. Each specific level of risk or return requires

a separate solver run. This takes a great deal of time.

Below are the results for a three asset model where the expected returns and variance of returns are

E(return) Risk

Asset A 20.00% 28.00%

Asset B 18.00% 33.00%

Asset C 33.00% 40.00%

the covariance matrix is

Asset A Asset B Asset C market price of risk

Asset A 7.84% 3.41% 1.72% risk free rate

Asset B 3.41% 10.89% 2.84%

Asset C 1.72% 2.84% 16.00%

and the correlation matrix is

Asset A Asset B Asset C

Asset A 100.00% 36.94% 15.39%

Asset B 36.94% 100.00% 21.48%

Asset C 15.39% 21.48% 100.00%

efficient frontier

risk return % of asset A % of asset B % of asset C

70.76% 0.00% 100.59% 132.82% -133.41%

65.14% 2.00% 96.14% 123.35% -119.48%

59.59% 4.00% 91.68% 113.88% -105.56%

54.13% 6.00% 87.23% 104.40% -91.63%

48.80% 8.00% 82.77% 94.93% -77.70%

43.62% 10.00% 78.32% 85.46% -63.78%

41.11% 11.00% 76.09% 80.72% -56.81%

38.67% 12.00% 73.86% 75.99% -49.85% short selling

36.31% 13.00% 71.64% 71.25% -42.88%

34.05% 14.00% 69.41% 66.51% -35.92%

31.91% 15.00% 67.18% 61.78% -28.96%

29.92% 16.00% 64.95% 57.04% -21.99%

28.10% 17.00% 62.73% 52.30% -15.03%

26.49% 18.00% 60.50% 47.57% -8.07%

25.13% 19.00% 58.27% 42.83% -1.10%

24.07% 20.00% 56.04% 38.10% 5.86%

23.35% 21.00% 53.82% 33.36% 12.82%

22.99% 22.00% 51.59% 28.62% 19.79% no short selling

23.00% 22.90% 49.60% 24.33% 26.07%

24.00% 24.77% 45.38% 15.51% 39.11%

25.00% 25.75% 43.23% 10.90% 45.87%

26.00% 26.52% 41.58% 7.17% 51.25%

27.00% 27.19% 40.11% 3.97% 55.92%

28.00% 27.80% 38.70% 1.12% 60.17%

29.00% 28.37% 37.53% -1.63% 64.10%

30.00% 28.90% 36.28% -4.11% 67.83%

Page 6

results

50.00% 37.31% 17.43% -43.86% 126.43%

60.00% 41.00% 9.25% -61.38% 152.13%

70.00% 44.59% 1.28% -78.36% 177.08% short selling

80.00% 48.11% -6.46% -95.12% 201.58%

90.00% 51.59% -14.22% -111.60% 225.82%

100.00% 55.04% -21.74% -128.10% 249.85%

110.00% 58.48% -29.41% -144.36% 273.77%

120.00% 61.90% -36.96% -160.61% 297.57%

130.00% 65.31% -44.60% -176.72% 321.32%

140.00% 68.71% -52.13% -192.86% 344.99%

150.00% 72.10% -59.77% -208.87% 368.64%

Page 7

results

0.79019019

6.00%

risk return

0.00% 6.00%

4.00% 9.16%

8.00% 12.32%

12.00% 15.48%

16.00% 18.64%

20.00% 21.80%

24.00% 24.96%

28.00% 28.13%

32.00% 31.29%

36.00% 34.45%

40.00% 37.61%

44.00% 40.77%

48.00% 43.93%

52.00% 47.09%

56.00% 50.25%

60.00% 53.41%

64.00% 56.57%

o short selling 68.00% 59.73%

72.00% 62.89%

76.00% 66.05%

80.00% 69.22%

84.00% 72.38%

88.00% 75.54%

92.00% 78.70%

96.00% 81.86%

100.00% 85.02%

Page 8

results

104.00% 88.18%

108.00% 91.34%

112.00% 94.50%

116.00% 97.66%

120.00% 100.82%

124.00% 103.98%

128.00% 107.14%

132.00% 110.31%

136.00% 113.47%

140.00% 116.63%

144.00% 119.79%

148.00% 122.95%

Page 9

graphs

80%

60%

return

40%

20%

0%

0% 25% 50% 75% 100% 125%

risk

80%

60%

return

40%

20%

Page 10

40%

graphs

20%

0%

0% 25% 50% 75% 100% 125%

risk

Page 11

graphs

assets

Page 12

graphs

Page 13

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