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Efficient frontier for stock portfolios
Back to topic: The Math and Models behind the Strategies

STRATxAI

May 2024 · 5 min read

Efficient Frontier

Research
Educational
Intermediate

What is the efficient frontier ?

The efficient frontier is a risk versus return plot that illustrates which portfolio is optimal to hold for your given level of risk. This was inspired by academic work from Harry Markowitz in the 1950s.

A portfolio is just a weighted combination of a set of stocks. By definition, each stock in your portfolio has an expected return and expected risk level associated with it. These expected return and expected risks are key to deciding which stocks you want to hold in your portfolio. The risk and return can be estimated via complex mathematical models and this is what the alpha-generating hedge fund industry focuses on, where alpha refers to future expected returns.

For this article, what can we do if we do not have access to these sophisticated estimation methods for risk and return ? We can use a very simple heuristic which is that we expect future risk and return to equal the past risk and return - so let's go with that model assumption for this article.

What do we mean when we say Portfolio A dominates Portfolio B ?
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