Student Name: Akash Sharma

Student ID: 2221014

Date: November 9, 2022

APT - I
Assignment 3

Problem 1: Simplify the expressions a′ .V.a and b′ .V.a

Background: Results from Minimization of Mean Variance:

Consider portfolio with N-risky assets, such that:

Each Asset’s Expected Returns as an n*1 vector, R̄ = (R̄1 , R̄2 , ...R¯N )′

Each Asset’s Weightage as an n*1 vector, w = (w1 , w2 , ...wN )′

X N
With the Total Weightage as, 1 = w′ .e = wi
i=1

So we have,
N
X
Expected Portfolio Return, (Weighted Average), R¯p = w′ .R̄ = wi .R̄i
i=1

Variance of Portfolio Return, σp 2 = w′ V w

 
Where, σ2 σ12 ... σ1N
 1 
 
 σ21 σ22 ... σ2N 
Variance-Covariance Matrix, V =
 

 . . . . 
 
 
2
σN 1 σN 2 ... σN

For the positive definite matrix V, we have w′ .V.w > 0, so σP2 ≥ 0. Evaluating the portfolio vari-

ance as the Quadratic Form yields,

     ′  
σ12 σ12 ... σ1N w1 (w1 σ12 + w2 σ21 + ... + wN σN 1 ) w
       1
        
 σ21 σ22 ... σ2N 
  w2 
 (w1 σ12 + w2 σ 2 + ...wN σN 2 )   w2 
  
2
σp 2 = w1 wN .  .  =  . 
    
w2 ...
 . . . .   ...  ...   ... 
       

       
2 2
σN 1 σN 2 ... σN wN (w1 σ1N + w2 σ2N + ...wN σN ) wN


w1 2 σ1 2 + w1 w2 σ21 + ... + w1 wN σN 1



 +



w w σ + w 2 σ 2 + ... + w w σ


1 2 12 2 2 2 N N2 +
σp2 =




 + . . . +



w1 wN σ1N + w2 wn σ2N + ... + wN 2 σN 2


For the Efficient Portfolio, for a given Expected Return (R̄p ), we minimize the portfolio variance (σp2 ),

such that the objective function is,

1 ′
min w Vw
w 2
which yields the optimal portfolio with portfolio weights:

w∗ = a + b.R¯p

such that,
β.V −1 .e − α.V −1 .R̄ δ.V −1 .R̄ − α.V −1 .e
a= b=
βδ − α2 βδ − α2

Which implies,
′
β.V −1 .e − α.V −1 .R̄
  
′ 1
a = = .(β.e′ .V −1 ′ − αR̄′ .V −1 ′ )
βδ − α2 βδ − α2

′
δ.V −1 .R̄ − α.V −1 .e
  
′ 1
b = = .(δ.R̄′ .V −1 ′ − α.e′ .V −1 ′ )
βδ − α2 βδ − α2

Where,

α = e′ .V.R̄ β = R̄′ .V −1 .R̄ δ = e′ .V −1 .e

Now evaluating the expression a′ .V.a, we have first,

β.V −1 .e − α.V −1 .R̄

 
V.a = V.
βδ − α2
 
1
= .(βV.V −1 .e − αV.V −1 .R̄)
βδ − α2
 
1
= .(β.e − α.R̄)
βδ − α2

Which implies,

 2
′ 1
. (β.e′ .V −1 ′ − αR̄′ .V −1 ′ ).(β.e − α.R̄)
 
a .V.a =
βδ − α2
 2
1
. β 2 .e′ .V −1 ′ .e + α2 R̄′ .V −1 ′ .R̄ − α.βe′ .V −1 ′ .R̄ − α.β R̄′ .V −1 ′ .e
 
= 2
βδ − α
 2
1
. β 2 .e′ .V −1 .e + α2 R̄′ .V −1 .R̄ − α.β R̄′ .V −1 .e − α.β.e′ .V −1 .R̄
 
=
βδ − α2
 2
1
. β 2 .δ + α2 .β − α2 .β − α2 β
 
= 2
βδ − α
 
β
=
βδ − α2
 
β
∴ a′ .V.a =
βδ − α2
And similarly,

 2
′ 1
. (δ.R̄′ .V −1 ′ − α.e′ .V −1 ′ .(β.e − α.R̄)]


b .V.a = 2
βδ − α
 2 
1  ′ −1 ′ ′ −1 ′ ′ −1 ′ 2 ′ −1 ′
= . β.δ. R̄ .V .e − α.δ.R̄ .V .R̄ − α.β.e .V .e + α .e .V .R̄
βδ − α2
 2 
1  ′ −1 ′ −1 ′ −1 2 ′ −1
= . β.δ.e .V .R̄ − α.δ.R̄ .V .R̄ − α.β.e .V .e + α .R̄ .V .e
βδ − α2
 2
1
. αβδ − αβδ − αβδ + α3
 
= 2
βδ − α
 
−α
=
βδ − α2
 
−α
∴ b′ .V.a =
βδ − α2