Question

Asset Allocation (20%)

Define mean/variance asset allocation optimization Include an objective function and two constraints in your answer (either in words or equations, both is better). An illustration is needed.

Answer 1

Mean/variance asset allocation optimization is a strategy used by investors to allocate their investments among different asset classes in order to maximize returns while minimizing risk. It involves selecting a portfolio that achieves the highest expected return for a given level of risk.

Step-by-step explanation:

Mean/variance asset allocation optimization is a strategy used by investors to allocate their investments among different asset classes in order to maximize returns while minimizing risk. It involves selecting a portfolio that achieves the highest expected return for a given level of risk.

The objective function in mean/variance asset allocation optimization is to maximize the expected return of the portfolio while minimizing the portfolio's variance (or risk). The constraints typically include the requirement that the sum of the allocation weights must equal 1 and that the weights must be non-negative.

For example, let's consider an investor who has $100,000 to invest and wants to allocate it among stocks and bonds. The objective function would be to maximize the expected return of the portfolio, while the constraints would be that the sum of the allocation weights (w) must equal 1 (w1 + w2 = 1) and that the weights must be non-negative (w1 >= 0, w2 >= 0).