Analytical Research Report on a Portfolio Management Problem
On page 7.2 of the Excel sheet you should be able to observe the mean returns from the historical data, the standard deviations, correlations and the covariances. Undertake the following:
• Using the historical mean as the expected return, use the portfolio optimisation procedure in the Excel sheet to determine the portfolio weights of the optimal risky portfolio and the optimal complete portfolio. Select your own estimate of risk aversion for the individual stating what would happen if risk aversion changes (either up or down) from your own initial estimate. (You are given the chance to select a level of risk aversion, in part, to ensure you have flexibility over the diagram demonstrating the optimal complete portfolio and optimal risky portfolio.)
• Imagine you are doing security analysis on some of the stocks, what happens when you change the expected return? Select a security (or securities) of your choice and analyse the results.
• Compare the portfolio weights for both the optimal risky portfolio and the optimal complete portfolio using the portfolio optimisation procedure in the Excel sheet for the three methods to forecast expected returns, a), historical, b) static CAPM, and c) Fama-French 3 factor. Offer an interpretation of your findings.
When your analysis is complete write up your results as if you were presenting them to your client. Use graphs and tables. (You do not need to present all the results. Just select the ones that seem the most important to you and justify the reasons why you have chosen those particular results.) Make clear the weaknesses and strengths (referring to academic and professional papers where appropriate) of your analysis and recommend a course of action for your client.
