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Financial Modeling with Crystal Ball and Excel Chapter 9

CHAPTER 9 Portfolio Models Crystal Ball is very useful for investigating different allocations of investment funds to a set of risky assets. This chapter demonstrates the use of Crystal Ball and OptQuest for determining the optimal allocation of funds in an investment portfolio based on the decision maker’s risk tolerance. | 9 Portfolio Models Crystal Ball is very useful for investigating different allocations of investment funds to a set of risky assets. This chapter demonstrates the use of Crystal Ball and OptQuest for determining the optimal allocation of funds in an investment portfolio based on the decision maker s risk tolerance. We use Crystal Ball and OptQuest to find an optimal allocation for a situation where we know the true optimal allocation and one where we do not. SINGLE-PERIOD CRYSTAL BALL MODEL In this example we consider investing in the five asset classes listed in Table 9.1. Figure 9.1 shows a segment of the single-period Crystal Ball model in Portfolio.xls. Cells B12 E88 contain annual rates of return in percent on four asset classes. These rates of return were calculated from the indices contained in the Indices worksheet of Portfolio.xls. The indices were constructed from data collected from various sources for use only in the examples presented in this book. For more specific data on asset returns available to investors during the period 1926-2002 and more see the Center for Research in Security Prices www.crsp.com Ibbotson Associates 2006 or Bodie Kane and Marcus 2008 . Overview. Assume that you have four asset classes from which to choose for an investment portfolio. These classes are listed in Table 9.1 along TABLE 9.1 Means and standard deviations for annual total returns 1 r during the period 1926-2002 for four asset classes. Asset Class Name Mean Return Std. Dev. Large-Company Stocks LCS 1.1212 0.2052 Small-Company Stocks SCS 1.1734 0.3607 Corporate Bonds CB 1.0595 0.0794 U.S. Government Bonds USGB 1.0559 0.0699 132 Portfolio Models 133 FIGURE 9.1 Spreadsheet segment from model to simulate a portfolio. TABLE 9.2 Pearson correlation matrix for annual total returns during the period 1926-2002 for four asset classes. LCS SCS CB USGB LCS 1 SCS 0.787 1 CB 0.174 0.035 1 USGB 0.104 -0.032 0.948 1 with their historical mean total returns and standard deviations. .