Portfolio Optimization Research Paper Example | Topics and Well Written Essays - 500 words

Portfolio Optimization - Research Paper Example ). The investor treats the national market as a global market with all its different industrial sectors where each sector symbolizes a national market. The diverse industrial sectors are to some extent uncorrelated and will provide a positive excess return and consequently should be added to the portfolio. Search for the window of opportunity with mathematical tools, the statistical result gives the investor an indication of the suitability of the opportunity in the perspective of the investor’s aversion to risk. When allocating the portfolio from a global point of view, it is important to be aware of that the transaction costs probably will rise to a great extent (Litterman, 2003). The efficient frontier solves the question of how to identify the best level of diversification. The concept of an efficient frontier can be applied in a number of ways. In essence, an efficient frontier is a curve on a graph representing the relationship between return and risk for a set of portfolios. For a portfolio to be on the efficient frontier, the portfolio must maximize return for a given level of risk (Litterman, 2003). It is simple concepts that risk and return are linked together and that there is a relationship between them, and thus there could be a way to determine the degree of risk that would be required for various levels of return. According to Litterman (2003). it is hard to generate high returns without exposing yourself to some kind of risk. Litterman (2003).devised what he called the efficient frontier, a trade-off graph with the expected return on one axis and risk on the other axis. It is a curve representing all portfolios that maximize the expected return for a given level of risk. The efficient frontier is simply a line drawn from the bottom left to the top right where each point on that line represents an intersection between potential reward and its corresponding level of risk. The most