Feasible Set of Portfolios 🌐📈
Before we talk about "efficient" portfolios, we must first understand the Total Universe of possibilities. This is known as the Feasible Set (or Opportunity Set).
1. Defining the Feasible Set
The Feasible Set represents every possible combination of assets (within specific constraints like weights summing to 1.0) that can be built from a given group of securities.
Imagine you have 3 stocks. You can put 100% in one, or 33% in each, or 50% in two and 0% in the third.
- Each mixture results in a unique Expected Return and Risk (Standard Deviation).
- When we plot every single one of these mixtures on a graph, the area they cover is the Feasible Set.
2. Shape of the Feasible Set
If you have a large number of stocks, the feasible set looks like an umbrella or an "Egg" shape:
- The Boundary (Edges) contains portfolios with specific mixes.
- The Interior (Inside) contains millions of other possible combinations.
The Feasible Set defines the outer limits of what is physically possible in the investment world. You cannot achieve a point outside the feasible set using the given stocks.
3. The Left-Hand Boundary
The most important part of the feasible set is its left-most edge.
- This edge represents portfolios that have the Minimum Risk for their level of return.
- From this set of "boundary portfolios," we will eventually filter out the "Dominant" ones to find the Efficient Frontier.
Summary
- The Feasible Set is the collection of all possible portfolios.
- It covers a specific area in the risk-return graph.
- The Lower and Right parts of the feasible set are generally inefficient.
- The Upper-Left boundary is where the best investments are found.
Quiz Time! 🎯
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