Efficient Frontier with Nordstrom, Starbucks and Microsoft

Monthly data from 1995 - 1999

0.100
0.090
0.080

Efficient Frontier of T-bills and

Risky Assets

0.070
0.060
Portfolio ER

Frontier
Nordstrom
Starbucks
Microsoft
Global Min
Tangency
Tan + T-bills

Tangency
portfolio

0.050
Microsoft

0.040
0.030

Starbucks
Efficient Frontier of Risky
Assets

0.020

rf

0.010
0.000
0.000

Global min
portfolio
Nordstrom
0.050

0.100
Portfolio SD

0.150

0.200

0.250

VaR Frontier
$108,000

$107,000

Expected Portfolio Gain

$106,000

$105,000

$104,000

$103,000

$102,000

$101,000

$100,000
$8,000

$10,000

$12,000

$14,000
5% Portfolio VaR

$16,000

$18,000

$20,000

Three-firm case: Computing the efficient frontier using Matrix Algebra

mu

Inputs to Markowitz Algorithm

Stock
E[R]
SD(R)
Nordstrom
0.15%
10.55%
Starbucks
2.85%
14.22%
Microsoft
4.27%
10.06%

covmat
VAR(R)=varcov
0.011
0.003
0.003
0.020
0.002
0.001

0.002
0.001
0.010

Computing the Portfolio frontier for the risky assets is a multi-step process (Markowitz algorithm)
Step 1. Find the global minimum variance portfolio, compute its mean and variance
Step 2. Determine an efficent portfolio with target return equal to the largest expected return of the given set of as
mean and variance
Step 3. Compute the covariance between the returns on the global minimum variance portfolio found in step 1 an
the efficient portfolio found in step 2.
Step 4. Compute portfolio frontier using result that any portfolio on the frontier is a convex combination of any tw
portfolios.

Step 2

p1vec
Step 1

gvec

Computing an efficient portfolio using the "solver"

Problem: minimize x'x subject to x'1 = 1 and x'= 0
target
x1
x2
x3
Constraint 1 Constraint 2 Var(Rp)
0.043
-0.091
0.262
0.829
1.000
0.043
0.009
Computing the global minimum variance portfolio using the "solver"
Problem: minimize x'x subject to x'1 = 1
x1
x2
x3
Constraint 1
Var(Rp)
0.364
0.194
0.442
1.000
0.005

PORTFOLIO STATISTICS
E[Rp]
VAR(Rp) SD(Rp) Cov(Rp1,Rgmin)
Port 1
0.043
0.009
0.092
0.005
Global min
0.025
0.005
0.073
covp1gmin
mugmin vargmiin
Computing tangency portfolio using the solver
T-bill rate
0.01
Problem: maximize Sharpe slope = (x' - rf)/sqrt(x'x) subject to x'1 = 1
x1
tvec

Tangency

x2
x3
Constraint 1
E[Rp] - rf
Var(Rp)
Slope
-0.548
0.330
1.218
1.000
0.051
0.018
0.376
PORTFOLIO STATISTICS
E[Rp]
VAR(Rp) SD(Rp)
0.061
0.018
0.134
mutan
sdtan
Problem: maximize Sharpe slope = (x' - rf)/sqrt(x'x) subject to x'1 = 1 and x(i) >= 0
x1
x2
x3
Constraint 1
E[Rp] - rf
Var(Rp)
Slope

tvec2

Tangency

0.000
0.190
0.810
PORTFOLIO STATISTICS
E[Rp]
VAR(Rp) SD(Rp)
0.040
0.008
0.088

1.000

0.030

Weights in global min var portfolio

1.000
0.800
weights

0.600
0.400
0.200
0.000
-0.200
Nordstrom

Starbucks

Microsoft

assets

Weights in tangency portfolio

1.500

Weights

1.000
0.500
0.000
-0.500
-1.000
Nordstrom

Starbucks
Assets

Microsoft

0.008

0.342

5% Value-at Risk Calculations

W0
$ 100,000

rkowitz algorithm)
ance
pected return of the given set of assets, compute its

50000000 7071.0678

ariance portfolio found in step 1 and the returns on

is a convex combination of any two frontier

Determine Efficient Frontier of Risky Assets Only

xp1
xgmin
E[Rp]
var(Rp)
SD(Rp)
0
1
0.025
0.005
0.073
0.1
0.9
0.027
0.005
0.073
0.2
0.8
0.029
0.005
0.074
0.3
0.7
0.030
0.006
0.075
0.4
0.6
0.032
0.006
0.077
0.5
0.5
0.034
0.006
0.078
0.6
0.4
0.036
0.006
0.081
0.7
0.3
0.037
0.007
0.083
0.8
0.2
0.039
0.007
0.086
0.9
0.1
0.041
0.008
0.089
1
0
0.043
0.009
0.092
1.1
-0.1
0.044
0.009
0.096
1.2
-0.2
0.046
0.010
0.100
1.3
-0.3
0.048
0.011
0.103
1.4
-0.4
0.050
0.012
0.107
1.5
-0.5
0.052
0.012
0.112
1.6
-0.6
0.053
0.013
0.116
1.7
-0.7
0.055
0.014
0.120
1.8
-0.8
0.057
0.016
0.125
1.9
-0.9
0.059
0.017
0.130
2
-1
0.060
0.018
0.134
2.1
-1.1
0.062
0.019
0.139
2.2
-1.2
0.064
0.021
0.144
2.3
-1.3
0.066
0.022
0.149
2.4
-1.4
0.068
0.024
0.154
2.5
-1.5
0.069
0.025
0.158

5% VaR calculations for portfolios

E[W1]
SD(W1)
$102,497 $ 7,317
$102,674 $ 7,338
$102,852 $ 7,403
$103,029 $ 7,509
$103,207 $ 7,655
$103,384 $ 7,839
$103,561 $ 8,057
$103,739 $ 8,309
$103,916 $ 8,589
$104,094 $ 8,897
$104,271 $ 9,228
$104,449 $ 9,581
$104,626 $ 9,954
$104,803 $ 10,343
$104,981 $ 10,748
$105,158 $ 11,167
$105,336 $ 11,597
$105,513 $ 12,039
$105,691 $ 12,490
$105,868 $ 12,950
$106,045 $ 13,418
$106,223 $ 13,893
$106,400 $ 14,374
$106,578 $ 14,861
$106,755 $ 15,353
$106,933 $ 15,849

Determine Efficient Frontier of Risky Assets and T-bills

xtan
E[Rp]
SD(Rp)
0
0.010
0.000
0.1
0.015
0.013
0.2
0.020
0.027
0.3
0.025
0.040
0.4
0.030
0.054
0.5
0.035
0.067
0.6
0.040
0.081
0.7
0.045
0.094
0.8
0.050
0.108
0.9
0.056
0.121
1
0.061
0.134
1.1
0.066
0.148
1.2
0.071
0.161
1.3
0.076
0.175
1.4
0.081
0.188
1.5
0.086
0.202

lculations for portfolios

q(0.05)
VaR
$ 90,462 $ 9,538
$ 90,604 $ 9,396
$ 90,675 $ 9,325
$ 90,678 $ 9,322
$ 90,616 $ 9,384
$ 90,491 $ 9,509
$ 90,308 $ 9,692
$ 90,072 $ 9,928
$ 89,788 $ 10,212
$ 89,460 $ 10,540
$ 89,092 $ 10,908
$ 88,689 $ 11,311
$ 88,253 $ 11,747
$ 87,790 $ 12,210
$ 87,302 $ 12,698
$ 86,791 $ 13,209
$ 86,260 $ 13,740
$ 85,711 $ 14,289
$ 85,146 $ 14,854
$ 84,567 $ 15,433
$ 83,975 $ 16,025
$ 83,371 $ 16,629
$ 82,757 $ 17,243
$ 82,134 $ 17,866
$ 81,502 $ 18,498
$ 80,863 $ 19,137

Mar-95
Apr-95
May-95
Jun-95
Jul-95
Aug-95
Sep-95
Oct-95
Nov-95
Dec-95
Jan-96
Feb-96
Mar-96
Apr-96
May-96
Jun-96
Jul-96
Aug-96
Sep-96
Oct-96
Nov-96
Dec-96
Jan-97
Feb-97
Mar-97
Apr-97
May-97
Jun-97
Jul-97
Aug-97
Sep-97
Oct-97
Nov-97
Dec-97
Jan-98
Feb-98
Mar-98
Apr-98
May-98
Jun-98
Jul-98
Aug-98
Sep-98
Oct-98
Nov-98
Dec-98
Jan-99
Feb-99
Mar-99
Apr-99

Nordstrom Starbucks Microsoft

-0.036
0.005
0.121
-0.057
-0.021
0.139
0.078
0.212
0.035
-0.003
0.204
0.065
-0.028
0.048
0.001
0.028
0.068
0.022
0.012
-0.055
-0.022
-0.119
0.036
0.100
0.060
0.074
-0.138
0.031
-0.006
0.007
-0.031
-0.226
0.053
0.142
0.051
0.065
0.071
0.280
0.044
0.049
0.151
0.094
0.005
0.000
0.047
-0.136
0.041
0.012
-0.070
-0.083
-0.019
-0.059
0.231
0.038
-0.026
0.008
0.074
-0.052
-0.015
0.040
0.190
0.063
0.134
-0.205
-0.190
0.052
0.047
0.179
0.211
-0.007
-0.018
-0.045
0.030
-0.127
-0.061
0.036
0.008
0.282
0.204
0.053
0.020
0.022
0.212
0.019
0.144
0.050
0.112
0.034
0.002
-0.067
0.086
0.020
0.001
-0.040
-0.237
-0.018
-0.035
0.055
0.085
0.023
0.096
-0.091
-0.171
-0.048
0.143
0.122
0.079
0.128
0.107
0.136
0.055
0.025
0.060
0.007
0.098
-0.003
-0.061
0.070
0.107
0.245
-0.213
-0.244
0.014
-0.040
-0.283
-0.136
-0.190
0.137
0.137
0.099
0.181
-0.039
0.312
0.061
0.142
-0.071
0.196
0.128
0.182
-0.075
0.233
-0.032
0.015
-0.153
0.015
0.060
0.177
-0.150
0.275
-0.097

mean
var
sd

Nordstrom Starbucks Microsoft

0.15%
2.85%
4.27%
1.11%
2.02%
1.01%
10.55%
14.22%
10.06%

Covariance Matrix
Nordstrom Starbucks Microsoft
Nordstrom
0.011
0.003
0.002
Starbucks
0.003
0.020
0.001
Microsoft
0.002
0.001
0.010
Correlation Matrix
Nordstrom Starbucks Microsoft
Nordstrom
1.000
0.176
0.174
Starbucks
0.003
1.000
0.001
Microsoft
0.174
0.079
1.000

May-99
Jun-99
Jul-99
Aug-99
Sep-99
Oct-99
Nov-99
Dec-99
Jan-00

0.011
-0.058
-0.064
-0.102
-0.047
-0.079
0.112
-0.055
-0.179

-0.002
0.018
-0.480
-0.016
0.080
0.093
-0.023
-0.091
0.277

-0.008
0.111
-0.050
0.076
-0.022
0.022
-0.017
0.249
-0.176

Means and variances are computed using

the usual descriptive statistics

The covariance matrix may be quickly computed

using Tools/Data Analysis/Covariance. Use
copy/Paste special/Transpose to fill in
covariance matrix

The correlation matrix may be quickly computed

using Tools/Data Analysis/Correlation. Use
copy/Paste special/Transpose to fill in
correlation matrix