OPTIMAL RISKY PORTFOLIO:
CAPITAL ALLOCATION BETWEEN RISK-FREE AND RISKY ASSETS
The optimal capital allocation is the goal of each investor. One way to form an optimal portfolio and maximise the investor’s utility is by maximising the Sharp ratio.
This report uses monthly return data of the 10 major sectors in the ASX300 from January 2004 until December 2015. The analysis is based on the assumptions, that the investor has the possibility to borrow or lend money at the same risk-free rate of 0,4% per month and is able to short-sell his assets without any transaction costs.
In comparison with the actual ASX300 index returns, equal weighted portfolios and overall expected industry returns basis this approach should be analysed to what extent it can be used to form optimal portfolios. To evaluate the data, …show more content…
Utility maximisation and the significance of diversification
The two diagrams show the different utilities surmise from the individual portfolios in period 1 and 2 in blue and the utility of the optimal combined portfolio in orange. Even if the utility might me higher for some sectors in one period, we see a big difference between the periods. Whereas Energy provides the highest utility in period 1, the utility is highest for the telecommunications sector. Nevertheless the utility for the risk-averse investor is both times positive.
This shows the effect of the portfolio optimisation under the condition of utility maximisation for the investors risk profile. The risk or uncertainty consist of the non reducible market or systematic risk, which is affected by common macroeconomic factors, and the firm-specific risk. The firm-specific (or in this case industry specific) risk like success in research or personal development varies between companies and can be reduced by diversification.
Figure 5 Utility comparison: Investment optimal portfolio vs. one industry (Period 1: ’07 –
CAPITAL ALLOCATION BETWEEN RISK-FREE AND RISKY ASSETS
The optimal capital allocation is the goal of each investor. One way to form an optimal portfolio and maximise the investor’s utility is by maximising the Sharp ratio.
This report uses monthly return data of the 10 major sectors in the ASX300 from January 2004 until December 2015. The analysis is based on the assumptions, that the investor has the possibility to borrow or lend money at the same risk-free rate of 0,4% per month and is able to short-sell his assets without any transaction costs.
In comparison with the actual ASX300 index returns, equal weighted portfolios and overall expected industry returns basis this approach should be analysed to what extent it can be used to form optimal portfolios. To evaluate the data, …show more content…
Utility maximisation and the significance of diversification
The two diagrams show the different utilities surmise from the individual portfolios in period 1 and 2 in blue and the utility of the optimal combined portfolio in orange. Even if the utility might me higher for some sectors in one period, we see a big difference between the periods. Whereas Energy provides the highest utility in period 1, the utility is highest for the telecommunications sector. Nevertheless the utility for the risk-averse investor is both times positive.
This shows the effect of the portfolio optimisation under the condition of utility maximisation for the investors risk profile. The risk or uncertainty consist of the non reducible market or systematic risk, which is affected by common macroeconomic factors, and the firm-specific risk. The firm-specific (or in this case industry specific) risk like success in research or personal development varies between companies and can be reduced by diversification.
Figure 5 Utility comparison: Investment optimal portfolio vs. one industry (Period 1: ’07 –