1. Markowitz efficient frontier Econophysics Economics Haichen 4/30/2015

2. Assumptions of Markowitz Portfolio Theory 1.Investors consider each investment alternative as being presented by a probability distribution of expected returns over some holding period. 2. Investors minimize one-period expected utility, and their utility curves demonstrate diminishing marginal utility of wealth. 3. Investors estimate the risk of the portfolio on the basis of the variability of expected returns.

3. Assumptions of Markowitz Portfolio Theory 4. Investors base decisions solely on expected return and risk, so their utility curves are a function of expected return and the expected variance (or standard deviation) of returns only. 5. For a given risk level, investors prefer higher returns to lower returns. Similarly, for a given level of expected returns, investors prefer less risk to more risk.

4. Markowitz risk diversification Invest in assets that have low positive correlation or a negative correlation.

5. Expansion of Markowitz modelfree-risk interest asset no free-risk interest asset short sellingFinal ModelBlack Model no short sellingTobin ModelMarkowitz Model

6. Assume portfolio weights ( ) Expected Return Variance (Standard Deviation) of Returns

7. Covariance ：

8. How to get W ： is the return of the portfolio, is the risk of the portfolioi, then the question is to solve: Wi>=0 (no short selling)

9. PortfolioAverage return%risk IRCP4.960.087721132 APPL4.110.052699075 LEVYU4.390.127440516 LEVY3.310.085976235 NIKE2.330.051217275 PBCP2.100.066363293 QURE8.490.274116132 SCMP6.110.158430564 MTDR2.760.139361612 CHR3.800.085369942 NHTC13.930.213445932 TZF3.570.193861817

10. COV % IRCPAPPL LEVY U LEVYNIKEPBCP QUR E SCM P MTD R CHR NHT C TZF IRCP0.72-0.020.670.43-0.010.300.27-0.230.040.030.340.28 APPL-0.020.26-0.26-0.180.04-0.140.10.16-0.200.150.34-0.23 LEVY U 0.67-0.261.521.00-0.010.680.17-0.170.150.070.72-0.49 LEVY0.43-0.181.000.69-0.020.430.28-0.060.130.050.38-0.30 NIKE-0.010.04-0.01-0.020.24-0.05-0.160.18-0.23-0.010.050.33 PBCP0.30-0.140.680.43-0.050.410.27-0.130.160.030.25-0.27 QUR E 0.270.120.170.28-0.160.276.981.700.470.66-0.42-0.30 SCM P -0.230.16-0.17-0.060.18-0.131.702.34-0.500.18-0.09-1.27 MTD R 0.04-0.200.150.13-0.230.160.47-0.501.81-0.06-0.580.51 CHR0.030.150.070.05-0.010.030.660.18-0.060.68-0.11-0.49 NHT C 0.34 0.720.380.050.25-0.42-0.09-0.58-0.114.25-1.10 TZF0.28-0.23-0.49-0.300.33-0.27-0.30-1.270.51-0.49-1.103.51

11. Portfolio Efficient Frontier A: Minimum variance porfolio B: Maximum return portfolio

12. Portfolio Risk-Return Plots for Different Weights Standard Deviation of Return E(R) R ij = 0.00 R ij = +1.00 R ij = -1.00 R ij = +0.50 f g h i j k 1 2 R ij = -0.50

13. The Efficient Frontier and Investor Utility Different degree of risk aversion: High Medium Low

14. Selecting an Optimal Risky Portfolio X Y U3U3 U2U2 U1U1 U 3’ U 2’ U 1’

15. Modified Efficient Frontier retur n% IRCPAPPL LEVY U LEVYNIKEPBCP QUR E SCM P MTD R CHR NHT C TZF 2015 03 21.4 3 -3.14 48.3 2 31.5 0 3.31 23.3 8 4.651.171.205.84 37.3 8 - 18.8 3

16. IRC P APP L LEV YU LEV Y NIK E PBC P QU RE SC MP MT DR CHR NHT C TZF origi nal Max E[r] 13.9 3% 0.00 1.000.00 Min stde v 2.76 % 0.000.410.00 0.380.220.00 mo difie d Max E[r] 12.2 6% 0.00 1.000.00 Min stde v 1.92 % 0.000.020.000.290.080.610.00

17. Short selling allowed Short sell In order to profit from a decrease in the price of a security, a short seller can borrow the security and sell it expecting that it will be cheaper to repurchase in the future. solve ( without individual weight constraint)

18. Efficient Frontier with Short Selling

19. X’ is the optimal portfolio choice for more-risk averse investor  More-risk averse investor (a higher slope indifference curve) Y is the optimal portfolio choice for less-risk averse investor.  Less risk-averse investor (a lower slope indifference curve)

20. The riskfree asset: riskless lending and borrowing risk-free rate — risk-free lending — risk-free borrowing PP E[R] RfRf

21. The riskfree asset: riskless lending and borrowing Assume portfolio P consists of a risk-free asset and (n-1) risky assets. Then: so

22. The Efficient Frontier when Lending and Borrowing Possibilities Are Allowed Return Risk. rfrf Risk Free Return = super-efficient Portfolio Market Return = r m A Capital Market Line lending borrowing

23. The Efficient Frontier when Lending and Borrowing Possibilities Are Allowed r=0.22% A

24. Thank you Thanks for Chester and Antonio's help.