Portfolio optimization is an essential requirement of acquiring top investment opportunities. Random collection of equities and assets cannot guarantee success to the investors. Portfolio optimization can be done by individuals manually, still by using reliable and effective mathematical programs which are better known as optimizers. Companies use the optimization of portfolio models to rebalance and diversify their portfolios.
The investors look to strike the perfect balance between receiving optimal returns from investments and at the same time, specify the extent to which he would bear the burden of a risk. The two most important issues involved in portfolio optimization are as follows:
Risk measured by variance
Expected returns
A great portfolio optimizer will exploit the various complex correlation patterns of individual equities and assets, risks and expected returns to chalk out the best portfolio possible within a given situation. The following are the various models of portfolio optimization:
Markowitz Model:
This mathematical model of portfolio optimization was propounded by Professor Harry Markowitz. This model involves the making of a one-period portfolio which would maximize the expected return as much as possible. Of course, the tolerance of the investor regarding the risks of portfolio variance has to be considered. The inputs that are required in order to get the output of one-period optimal portfolio are as follows:
- The rate of return expected
- Level of wealth
- Risk Tolerance
- Volatility of assets available
Samuelson Model:
This involves the calculation of portfolio allocation and multi-period consumption policy that would lead to maximization of total expected utility over a fixed period of time. This theory looks to consume and reallocate wealth. The level of risk tolerance of the investor is a key concern in this case also. The outputs of portfolio allocation policy and multi-period optimal consumption while trading in discreet time can be achieved by putting in the following inputs:
- Price dynamics of available assets