The mean-variance model is a method used in finance to help investors make

decisions about which assets to invest in. It's based on two key concepts:
"mean," which represents the average return on an investment, and "variance,"
which measures how much the returns of an investment fluctuate around this
average.

Here's a simple explanation of how it works:

Mean (Average Return): Imagine you have several different investments, like
stocks or bonds. The mean return is the average return you expect to get from
each investment over a certain period, like a year.

Variance (Risk): Variance measures how much the actual returns of an

investment deviate from its mean return. If an investment's returns fluctuate a
lot, it has high variance, which means it's riskier. If the returns are more stable,
it has low variance and is considered less risky.

Balancing Risk and Return: The mean-variance model helps investors find the
best balance between risk and return. It does this by considering the expected
return and variance of each investment option. Investors aim to maximize their
expected return while minimizing their risk (variance).

Efficient Frontier: The mean-variance model also plots all possible

combinations of investments to find the optimal portfolio – the one that offers
the highest expected return for a given level of risk, or the lowest risk for a
given level of return. This collection of optimal portfolios is called the "efficient
frontier."

Portfolio Optimization: By analyzing the mean and variance of different assets

and their potential combinations, investors can construct portfolios that suit
their risk tolerance and investment goals
.
In essence, the mean-variance model helps investors make informed decisions
by weighing the potential return against the risk of their investments, ultimately
aiming to build portfolios that offer the best possible trade-off between risk and
return.

Sure, let's consider a simplified example using two stocks: Stock A and Stock
B.
Mean (Average Return):
Stock A: Expected annual return of 10%
Stock B: Expected annual return of 8%
Variance (Risk):
Stock A: Variance of 15% (high fluctuations)
Stock B: Variance of 5% (low fluctuations)

Now, let's say you're considering investing in a portfolio that includes both
Stock A and Stock B. You have a certain amount of money to invest and need
to decide how much to allocate to each stock.

Using the mean-variance model, you want to find the optimal allocation that
maximizes your expected return while minimizing your risk.

Let's plot this on a graph:

X-axis: Variance (Risk)
Y-axis: Mean (Average Return)

We can also connect all possible combinations of Stock A and Stock B to form
the efficient frontier.

Now, let's say you're comfortable with a certain level of risk and want to find
the portfolio that offers the highest return within that risk level.

For instance, if you're okay with a variance (risk) of 10%, you might find that a
portfolio allocation of 70% Stock A and 30% Stock B lies on the efficient
frontier and offers the highest expected return within your desired risk level.

By using the mean-variance model, you can analyze different combinations of

stocks to construct a portfolio that aligns with your risk tolerance and
investment objectives.