Sarah Di Cesare

Diana Valerio
Bao Chau Nguyen Huynh

The Report
Part 1: Constructing a Portfolio
The aim of this report is to construct a portfolio by attributing weights to the
following returns: the monthly returns on the 25 Fama-French portfolios, the 1month interest rate (the risk free rate) and the monthly returns on 10-year US
Government Bonds.
We completed the task by analyzing the observed returns for each of the
mentioned assets over ten years (from 1989:1 to 1999:12), since they can be
considered representatives of the overall performance in the market.
In order to determine the optimal portfolio, we computed weights as to minimize
portfolio Variance and to maximize portfolio Sharpe ratio using the Excels Solver
function.
We first set arbitrarily w=1 to the market portfolio and we set the objective of the
Solver as to minimize portfolio Variance by changing the variable cells of the
weights, allowing for negative values. Therefore, it is possible to short-sell assets
to increase the value of the complete portfolio.
The Expected Return of the Global Minimum Variance portfolio is the weighted
average of the component securities Expected Returns, with weights that
minimize the Variance:

And its Variance is the weighted sum of the elements of the Covariance matrix
with the product of the investment proportions as weights:

Sarah Di Cesare
Diana Valerio
Bao Chau Nguyen Huynh

From the Global Minimum Variance portfolio we drew the efficient frontier of risky
assets, and the optimal risky portfolio would be the one with the highest Sharpe
ratio, which lies on the CAL tangent to the efficient frontier. Therefore it yields the
highest possible return for any increase in the given Variance.

MinVar

MaxSharpe

We then found the weights that maximize the

Sharpe ratio. We observe that we obtained a

Mean
StdDev
Sharpe

0.42674029 0.42739664
0.09486963 0.09493894
4.49817573 4.50180528

exret_mkt
RF
PR11
PR12
PR13
PR14
PR15
PR21
PR22
PR23
PR24
PR25
PR31
PR32
PR33
PR34
PR35
PR41
PR42
PR43
PR44
PR45
PR51
PR52
PR53
PR54
PR55

Weights
0.16972265
0.99667623
-0.0162641
-0.0023773
0.00608469
-0.0115389
0.0274983
-0.0049788
0.00321234
-0.0050382
-0.0112197
-0.0102769
-0.004193
0.00477387
0.00520562
-0.0010182
0.01549974
-0.0074394
-0.0028365
-0.0053275
-0.0084304
-0.0124519
-0.0591962
-0.0182216
-0.0348966
-0.0048133
-0.0081551

Weights
0.17080258
0.99567562
-0.0162918
-0.002428
0.00614482
-0.0115918
0.02743143
-0.0049813
0.0032785
-0.0049054
-0.0112448
-0.0102439
-0.0042133
0.00466322
0.00525333
-0.0011516
0.01553788
-0.0074434
-0.0027703
-0.0053386
-0.0084458
-0.0123612
-0.0592454
-0.0183367
-0.0348967
-0.0047903
-0.0081072

Standard Deviation slightly higher than that of the

Global Minimum Variance portfolio, but a higher
Expected Return, suggesting this last one as the
optimal portfolio comprising the market, the riskfree asset and the 25 Fama-French portfolios.
From the computations it results that we should
invest 99.6% in the risk-free asset, 17% in the
market and short a combination of the 25 Fama
French Portfolios in order to realize a 42.74% return
with 9.5% volatility.

Part 2: Graphical Analysis of Returns

2

Sarah Di Cesare
Diana Valerio
Bao Chau Nguyen Huynh
We used EViews in order to graph the monthly returns of our portfolio with the
monthly returns on the market portfolio and the monthly returns on the risk free
asset.
The time-series graphs show that our portfolio returns are more stable than the
markets in terms of volatility even though they are lower (the average return of
our portfolio is 12.2% while that of the market portfolio is 31.7% over the years
2000:1 2015:12). On the other hand, our portfolio returns are extremely volatile
with respect to that of the risk free asset until 2008, when they abruptly
decreased and subsequently stabilized, showing fewer negative spikes.

The analysis of scatter plots reveals a positive linear relationship with the risk free
asset (=0.741163) due to the fact that our portfolio is highly invested in it.
Conversely, our portfolio shows little relationship with the market since we
invested a lower proportion of our portfolio in it
(=-0.003635).

Sarah Di Cesare
Diana Valerio
Bao Chau Nguyen Huynh

Sarah Di Cesare
Diana Valerio
Bao Chau Nguyen Huynh
To evaluate the validity of the normal
distribution to describe the monthly
returns of our portfolio we constructed
with EViews a Q-Q plot, which shows we
have right-skewed distributed data. The
same conclusion can be reached by
graphing a histogram with a normal
distribution superimposed.

The results indicate a very low probability that the monthly returns follow a
normal distribution, which is also shown by other tests.

Method

Value

Adj. Value

Probability

Lilliefors (D)
Cramer-von Mises (W2)
Watson (U2)
Anderson-Darling (A2)

0.088376
0.325372
0.266685
1.918050

NA
0.326224
0.267383
1.925699

0.0010
0.0002
0.0004
0.0001

Method: Maximum Likelihood - d.f. corrected (Exact Solution)

Parameter

Value

Std. Error

z-Statistic

Prob.

MU
SIGMA

0.001219
0.001590

0.000115
8.16E-05

10.58992
19.49359

0.0000
0.0000

Log likelihood
No. of Coefficients

960.2551
2

Mean dependent var.

S.D. dependent var.

0.001219
0.001590

Sarah Di Cesare
Diana Valerio
Bao Chau Nguyen Huynh

Since the return line of our portfolio lies within the upper and lower bound of the
Confidence Interval of the market portfolio, there is no statistical evidence that
the returns are different.