Efficient frontier
The portfolios with the highest expected return for each level of risk: the upper part of the minimum-variance frontier. Anything beneath it is beaten by something on it.
Where you will meet it
Efficient frontier appears in 6 learning outcomes on the CFA syllabus. A few of them:
- Work out the asset weights giving the lowest-variance mix of two risky assets
“Portfolios on the curve above the minimum-variance point form the efficient frontier; those below it offer lower return for the same risk and are never chosen.”
- Explain risk aversion and what indifference curves show
“The optimal portfolio is where the highest attainable indifference curve touches the efficient frontier, which is why two rational investors facing identical opportunities choose differently.”
- Explain how asset classes serve as building blocks for systematic risk exposures and set out the tests for defining an asset class
“A well-specified class meets several tests: its members are similar in risk and return characteristics; classes do not overlap; each diversifies the others, so its inclusion expands the efficient frontier; together the classes cover most of the investable wealth available; and each can absorb a meaningful share of the portfolio without liquidity problems.”
- Set out what the minimum-variance frontier and the efficient frontier are
“Its leftmost point is the global minimum-variance portfolio, and the portion above that point is the efficient frontier: no rational investor holds anything below it, because for every such portfolio there is another with the same risk and higher expected return.”
Learn it properly
Practise it
Practise efficient frontier until it is automatic: questions that explain every wrong option.
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