Portfolio Allocation Revisited EF

Author
Decisioneering, Inc.

Summary
This model is a continuation of the Portfolio Allocation example model (please see that model for the
basic Crystal Ball and OptQuest descriptions). In the example, you not only wish to determine an
optimal portfolio allocation strategy, but you wish to view alternative optimal portfolios at different
levels of risk. In this model, you will use OptQuest's Efficient Frontier option to achieve this goal.

Keywords: portfolio allocation, efficient frontier, optimization

Discussion
If you were to examine all the possible combinations of investment strategies for the given assets,
you would notice that each portfolio had a specific mean return and standard deviation of return
associated with it. Plotting the means on one axis and the standard deviations on another axis, you
can create a graph like this:

Points on or under the curve represent possible combinations of investments. Points above the curve
are unobtainable combinations given the particular set of assets available. For any given mean
return, there is one portfolio that has the smallest standard deviation possible. This portfolio lies on
the curve at the point that intersects the mean of return.
Discussion, cont.
Similarly, for any given standard deviation of return, there is one portfolio that has the highest mean
return obtainable. This portfolio lies on the curve at the point that intersects the standard deviation
of return.

Similarly, for any given standard deviation of return, there is portfolio that has the highest mean
return obtainable. This portfolio lies on the curve at the point that intersects the standard deviation
of return.

Portfolios that lie directly on the curve are called efficient (Reference Harry M. Markowitz. Portfolio
Selection. 2nd ed. Cambridge, MA: Blackwell Publishers, Ltd., 1991.), since it is impossible to
obtain higher mean returns without generating higher standard deviations, or lower standard
deviations without generating lower mean returns. The curve of efficient portfolios is often called the
efficient frontier. Portfolios that lie below the curve are called inefficient, meaning better portfolios
exist with either higher returns, lower standard deviations, or both.

The Portfolio Allocation example model uses one technique to search for optimal solutions on the
efficient frontier. This method uses the mean and standard deviation of returns as the criteria for
balancing risk and reward. You can also use other criteria for selecting portfolios. Instead of using
the mean return, you could select the median or mode as the measure of central tendency.

These selection criteria would be called median-standard deviation efficient or mode-standard

deviation efficient. Instead of using the standard deviation of return, you could select the variance,
range minimum, or low-end percentile as the measure of risk or uncertainty. These selection criteria
would be mean-variance efficient, mean-range minimum efficient, or mean-percentile efficient.

When should you use the Efficient Frontier function? This method is useful when it is difficult to
determine reasonable lower or upper bounds for requirement statistics.

Using Efficient Frontier

Start OptQuest from the Run menu. Once in OptQuest, use the File > Open option to open the
Portfolio Allocation Revisited EF.opt settings file in the Examples > OptQuest Files folder. Use the
OptQuest Wizard, either from the toolbar or from the Tools menu, to view the settings for the
optimization.
Using Efficient Frontier, cont.
The Efficient Frontier option is set in the Define Objective Window, and it is activated when you
select either the Variable Req. Upper Bound or Variable Req. Lower Bound. You will need to define
the number of optimal portfolios you wish to run, and the statistic you wish to set. In this example,
you want to test 10 portfolios starting with a lower risk standard deviation of $8000 and moving to a
higher risk standard deviation of $10,000.

Once you begin the optimization, you can watch the Efficient Frontier as it builds in the Efficient
Frontier window, which displays the best solutions for each requirement value and a graph of all
these best solutions. This window is only available if you have started an optimization
that includes a variable requirement. To access the Efficient Frontier window, either select Efficient
Frontier from the OptQuest View menu or click on the Efficient Frontier icon.

For more information on efficient frontiers and this model, read the model description in the
examples chapter in the OptQuest User Manual or visit the Decisioneering Web site
(http://www.crystalball.com).

Additional Resources
If you have Crystal Ball installed, you can run a simulation on this model. If you do not have a copy
of Crystal Ball, you can download a free, seven-day evaluation version from the Decisioneering
Web site:

http://www.crystalball.com

For other model resources and information, visit: http://models.crystalball.com.

Copyright and Contact Information

This spreadsheet model is the property of Decisioneering, Inc. Copyright (c) 2004 Decisioneering,
Inc. All Rights Reserved.

Microsoft is a registered trademark of Microsoft Corporation in the U.S. and other countries.

For questions concerning this model or the Crystal Ball software, contact the closest office listed on
our Web site (http://www.crystalball.com) or send an email to sales@crystalball.com. If you have a
technical problem with this model, please contact our support Help Desk:
helpdesk@crystalball.com.
 A B C D E F G H
1 Analisis de Portafolio
2
3 Rendimiento Limite Limite
4 Inversiones Anual Minimo Maximo
5 Fondo Alta Liquidez 3.0% $0 $50,000
6 Fondo Ingreso 5.0% $10,000 $25,000
7 Fondo Crecimiento e Ingreso 7.0% $0 $80,000
8 Fondo Agresivo 11.0% $10,000 $100,000
9 Total de Fondos Disponibles $100,000
10
11 Monto Total
Restricción
12 Variable Decisoria Invertido Fondos Disponibles
13 Fondo Alta Liquidez $25,000 $100,000
14 Fondo Ingreso $25,000 Variables Decisorias
15 Fondo Crecimiento e Ingreso. $25,000
16 Fondo Agresivo $25,000
17 Total de Rendimiento Esperado $6,500
18 Rendimiento
19 Esperado
20
21