[my XLS is here http://trtl.bz/frm-t1-7-ppc-xls] When correlations are imperfect, diversification benefits are possible. The portfolio possibiltiies curve illustrates this and it contains two notable points: the minimum variance portfolio (MVP) and the optimal portfolio (with the highest Sharpe ratio), At the end, I summarize four features of the PPC: 1. correlation, ρ, determines the shape of the PPC; 2. The minimum variance portfolio (MVP) is furtheest left (and has an easy analytical solution); 3. The (MVP) also slices the PPC into an lower convex segment and an upper concave segment which contains the dominating efficient portfolios; and 4. The theoretically optimal portfolio has the highest Sharpe ratio (and also has an analytical albeit less easy solution).

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4 COMMENTS

  1. I love the spreadsheet, but I think the 3rd term of right hand side is not correct. It should be 2*wA*wB*Cov(A,B), where Cov(A,B)=Corr*sdA*sdB

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