Merging the State-Space Representation and the Mean-Variance Characterization of the Efficient Frontier
22 Pages Posted: 8 Aug 2005
Date Written: May 2005
In financial economics the classical mean-variance characterization and the orthogonal state-space representation of the efficient frontier coexist. In this paper we establish a link between these approaches to the efficient frontier. The two orthogonal payoffs which span the efficient frontier in the state-space and the two portfolios which allow to construct the efficient frontier in the classical mean-variance world are related to each other explicitly. Basically, a decomposition of the two orthogonal spanning payoffs in the state-space is provided. The results allow to switch between both approaches to the efficient frontier quickly and easily.
Keywords: Portfolio theory, efficient frontier, mean-variance, state-space, spanning
JEL Classification: G11, G12
Suggested Citation: Suggested Citation