Lesson 7 of 8 · All lessons in this module
- Asset classes: return, risk and other characteristics
- Risk aversion and utilityVideo lesson
- Indifference curves and the capital allocation lineVideo lesson
- Measuring asset and portfolio riskVideo lesson
- Correlation and the power of diversificationVideo lesson
- Integrated cases: a foreign bond with currency, and pairs from a scenario table
- Minimum-variance and efficient frontiersVideo lesson
- Optimal risky portfolio and the optimal investor portfolioVideo lesson
Lesson 7 of 8 · 12 min
Minimum-variance and efficient frontiers
Of all the portfolios risky assets can form, only those on the upper half of the minimum-variance frontier, the efficient frontier, are worth holding.
In short
- The investment opportunity set is every risk–return combination that can be built from the available assets.
- Adding an asset class that is not perfectly correlated pushes the opportunity set northwest.
- The minimum-variance frontier holds the lowest-risk portfolio for each level of expected return.
- Its leftmost point is the global minimum-variance portfolio: no risky-asset portfolio has less risk.
- The part of the frontier above the global minimum-variance portfolio is the Markowitz efficient frontier; the part below is inefficient.
- Along the efficient frontier, each extra unit of risk buys less and less extra return.
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