Asset Allocation Model - Mean-Variance Optimization

All input cells in RED

Annual data Correlation Matrix

Asset Expected Standard Asset Asset
Return Deviation A B
Asset A 8% 12% 1.00 0.10
Asset B 13% 20% 0.10 1.00
Asset C 4% 6% -0.10 0.15

T-bill rate 2%
Variance-Covariance Matrix
Asset Asset
A B
Asset A 0.0144 0.0024
Asset B 0.0024 0.0400
Asset C -0.0007 0.0018

Min. Exp. Return (constraint) 5.0% 6.0% 7.0% 8.0%

w(A) 0.22 0.28 0.34 0.40
w(B) 0.02 0.10 0.18 0.27
w(C) 0.76 0.62 0.48 0.33
Sum (weight constraint) 1.00 1.00 1.00 1.00
Portfolio Variance (Target) 0.0026 0.0030 0.0042 0.0062
Portfolio Standard Deviation 5.13% 5.48% 6.47% 7.87%
Portfolio Expected Return 5.03% 6.00% 7.00% 8.00%
io E x p ected R etu rn

Sharpe Ratio 0.59 0.73 0.77 0.76

GLOBAL MINIMUM VARIANCE PORTFOLIO

 P o rtfo lio E x p ected R etu rn
w(A) 0.22
w(B) 0.02
w(C) 0.76
Sum 1.00
Portfolio Variance (Target) 0.0026
Portfolio Standard Deviation 5.13% 18.00%
Portfolio Expected Return 5.03% 16.00% Optimal Risky P
Sharpe Ratio 0.59 rf=2%, E(rP)=7.17%
14.00% Maximum Sharpe

OPTIMAL RISKY PORTFOLIO P 12.00%

w(A) 0.35 10.00%
w(B) 0.20
8.00%
w(C) 0.45
Sum 1.00 6.00%
Portfolio Variance 0.0045 4.00%
Portfolio Standard Deviation 6.69% 2.00%
Portfolio Expected Return 7.17%
0.00%
Sharpe Ratio (Target) 0.77 4.00% 6.00% 8.00% 1
 Instructions for using this sheet (this is a WORD document; double click to open it

relation Matrix
Asset
 Input your expected returns, standard deviations, and correlations in cells B7 to F9.
C historical returns. Expected returns are based on a combination of historical means
qualitative).
-0.10
 Input the current 3-month T-bill yield in cell B11.
0.15  In ROW 23, the minimum expected return should start from a number above the smallest
1.00 a value greater than your highest expected return (make sure you input the numbers are in
 Left click on TOOLS and choose SOLVER. Choose MIN since you want to minimize po
as your TARGET CELL, and cells B24:B26 as your CHANGING CELLS.
 In the constraints box, click the ADD button. In the left box, choose cell B27, in the mi
weights sum to 1 constraint). Click the ADD button again, in the left box choose cell B30
-Covariance Matrix cell B23 (this is the expected return constraint). If you have other constraints, enter the
Asset function and the right hand side is the constraint. Note: The solver in this sheet minimizes
 Click OPTIONS enter maximum time 20000 seconds and maximum iterations 10000. If y
C then check the box assume non-negative. Close the OPTIONS box and the control will
-0.0007 solution is found, the SOLVER RESULTS box will open up and give you the option of a
will give the optimal portfolio. Repeat the same procedure for columns C through N. Mak
0.0018 constraint cells from B to C, C to D, D to E, and so on. Now you will have different effic
expected returns (Y) against standard deviations (X), the efficient frontier, using the X-Y
0.0036
 To compute the global minimum variance portfolio (GMV) do the same thing as above b
are interested in constructing the lowest risk portfolio.
 To compute the optimal risky portfolio P choose cell B51 as your target cell, chang
portfolio with the maximum Sharpe ratio), choose your changing cells to be B44:B46 an
middle box choose = and in the right box enter 1 (this is the weights sum to 1 constrain
here since you are interested in the portfolio with highest return to risk ratio, i.e., highest

9.0% 10.0% 11.0% 12.0% 13.0% 14.0% 15.0%

0.46 0.53 0.59 0.65 0.71 0.78 0.84
0.35 0.43 0.52 0.60 0.68 0.77 0.85
0.19 0.04 -0.10 -0.25 -0.40 -0.54 -0.69
1.00 1.00 1.00 1.00 1.00 1.00 1.00
0.0090 0.0126 0.0170 0.0223 0.0283 0.0352 0.0428
9.48% 11.23% 13.05% 14.92% 16.83% 18.76% 20.70%
9.00% 10.00% 11.00% 12.00% 13.00% 14.00% 15.00%
0.74 0.71 0.69 0.67 0.65 0.64 0.63
 Efficient Frontier
Optimal Risky Portfolio P
rf=2%, E(rP)=7.17%, s P=6.69%
Maximum Sharpe Ratio = 0.77

Lower slope and

lower Sharpe
ratio

% 6.00% 8.00% 10.00%12.00%14.00%16.00%18.00%20.00%22.00%24.00%26.0

Portfolio Standard Deviation
ment; double click to open it)

and correlations in cells B7 to F9. Standard deviations and correlations are computed from
a combination of historical means and your subjective forecasting model (which may be

art from a number above the smallest expected return of the three risky assets and should end at
ake sure you input the numbers are in percent).
e MIN since you want to minimize portfolio variance. When the SOLVER box choose cell B28
ur CHANGING CELLS.
e left box, choose cell B27, in the middle box choose = and in the right box enter 1 (this is the
again, in the left box choose cell B30, in the middle box choose >= and in the right box choose
you have other constraints, enter them in the same manner. Note that the left hand side is the
ote: The solver in this sheet minimizes cell E28. Proceed similarly for other cells, one at a time.
ds and maximum iterations 10000. If you do not want negative weights (meaning no short-sales)
e OPTIONS box and the control will return to the SOLVER box and now click Solve
open up and give you the option of accepting the solution. Click OK and the cells B21 to B28
cedure for columns C through N. Make sure that you manually change the target, changing, and
on. Now you will have different efficient risky portfolios and expected return. You can plot the
, the efficient frontier, using the X-Y Plot.
(GMV) do the same thing as above but delete the minimum expected return constraint since we
o.
cell B51 as your target cell, change the objective to max from min (because you want the
your changing cells to be B44:B46 and your portfolio constraint left box to be cell B47, in the
his is the weights sum to 1 constraint). You do not need a minimum expected return constraint
ghest return to risk ratio, i.e., highest Sharpe Ratio.

16.0% 17% (Constraint cell 2)

0.90 0.96
0.93 1.02
-0.83 -0.98
1.00 1.00 (Constraint cell 1)
0.0513 0.0606
22.65% 24.62%
16.00% 17.00%
0.62 0.61
 Lower slope and
lower Sharpe
ratio

%22.00%24.00%26.00%