Simple Construction of the Efficient Frontier
9 Pages Posted: 24 Nov 2001
Date Written: November 11, 2002
We provide simple methods of constructing known results. At the core of our methods is the identification of a simple concise basis that spans the Capital Market Line (CML). We show that a portfolio whose risky assets weights are the product of the inverse variance-covariance matrix of (nonredundant) security rates of return times the vector of the excess expected rates of return over the risk-free rate is a CML portfolio. This portfolio and the risk-free security span the CML. In addition, with this basis, there is immediate construction of the efficient frontier of risky assets (the "hyperbola"), "tangency" portfolios, "reflection" portfolios, and a CAPM relationship. Our method is quick and simple. It is easy to derive, teach, implement, interpret, and remember.
Keywords: portfolio frontier, efficient frontier, capital market line, asset pricing
JEL Classification: G10, G11, G12
Suggested Citation: Suggested Citation