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A.K. Bardhan
Faculty of Management Studies
University of Delhi
x1 , x2 , ..., xn 0
Let x x1 , x2 , , xn
Max f ( x)
gi ( x) bi , i 1, 2, , m
16 C (2)
Loc. Dem.
14
A: (8,2) 19 D (5)
12
(7)
B: (3,10) 7 10
B
C: (8,15) 2 8
P ?
6
D: (14,13) 5
4
P: ? 2 A (19)
0 x
0 2 4 6 8 10 12 14 16
350
300 x=0
Objective value
250 x=2
200 x=4
x=6
150
x=8
100 x = 10
50 x = 12
0
values
for y
16 C (2)
14
D (5)
12
(7)
10
B
8
P ?
6
2 A (19)
0 x
0 2 4 6 8 10 12 14 16
5 ( x 14) ( y 13)
2 2
Subject to x 7
5 y 11
x + y 24
4.5
4
Millions of dollars
3.5
3 revenue
2.5
salvage
2
1.5 total
1
0.5
0
1
9
0.2
1.8
2.6
3.4
4.2
5.8
6.6
7.4
8.2
9.8
Time
• Interpretation:
– Suppose that the expected return in one year for Stock 1
is 9%.
– Suppose that the expected return in one year for Stock
2 is 10%
– If you put Rs. 100 in Stock 1, and Rs. 200 in Stock 2,
your expected return is Rs. 9 + Rs. 20 = Rs. 29.
• In general:
Var ( X i ) i j 2Cov( X i , X j )
n
Var(X1 + X2 + …+ Xn) = i 1
– Min Risk
s.t. Expected Return Bound
X Y Z
• What are the variables? X 3 1 0.5
Y 1 2 0.4
Z 0.5 0.4 1
Let X,Y,Z be percentage of portfolio of each asset.
Min 3 X 2 2Y 2 Z 2 2 XY XZ 0.8YZ
Max
1.3 X 1.2Y 1.08Z
st q (3 X 2 2Y 2 Z 2 2 XY XZ 0.8YZ )
X Y Z 1
X 0, Y 0, Z 0
Dr. A.K. Bardhan, Faculty of Management Studies, University of Delhi 31
More on Portfolio Selection
• Minimize Sj (rj)2
In an optimization
framework, one can
constrain coefficients.
100
90
80
Midterm Grade
70
60
50
r2 =.082
40
30
30 40 50 60 70 80 90 100
Avg of last 3 homeworks
100
90
midterm grades
80
70
60
r2 =.29
50
40
40 50 60 70 80 90 100
homework 3 grades
rs = a + b rm + e,
rs = return on stock s in the time period
rm = return on market in the time period
b = a 1% increase in stock market will lead to a b%
increase in the return on s (on average)
80.00%
60.00%
40.00%
Stock
20.00%
0.00%
-40.00% -20.00% 0.00% 20.00% 40.00% 60.00% 80.00%
-20.00% What is the best linear fit for
this data? What does one mean
-40.00%
by best?
-60.00%
Market 39
Dr. A.K. Bardhan, Faculty of Management Studies, University of Delhi
Regression, and estimating b
80.00%
60.00%
40.00%
Stock
20.00%
0.00%
-40.00% -20.00% 0.00% 20.00% 40.00% 60.00% 80.00%
The value b is the slope of the
-20.00% Market