Efficient Frontier

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DEFINITION of 'Efficient Frontier'

A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a given level of expected return. Portfolios that lie below the efficient frontier are sub-optimal, because they do not provide enough return for the level of risk. Portfolios that cluster to the right of the efficient frontier are also sub-optimal, because they have a higher level of risk for the defined rate of return.

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BREAKING DOWN 'Efficient Frontier'

Since the efficient frontier is curved, rather than linear, a key finding of the concept was the benefit of diversification. Optimal portfolios that comprise the efficient frontier tend to have a higher degree of diversification than the sub-optimal ones, which are typically less diversified.

The efficient frontier concept was introduced by Harry Markowitz in 1952 and is a cornerstone of modern portfolio theory.

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RELATED FAQS
  1. How have portfolios from within the efficient frontier performed historically?

    By definition, portfolios within the efficient frontier have historically performed well. Determining which portfolios operate ... Read Full Answer >>
  2. What are the advantages of portfolio planning with the efficient frontier?

    The advantages of portfolio planning with the efficient frontier are based in Harry Markowitz's modern portfolio theory (MPT), ... Read Full Answer >>
  3. How reliable is the mean variance analysis of an investment?

    Mean variance analysis of an individual investment or asset can provide a historical measure of volatility for the investment. ... Read Full Answer >>
  4. What level of correlation among investments will guarantee market returns but have ...

    The efficient frontier set forth by modern portfolio theory (MPT) can provide an estimate of an optimal portfolio that allows ... Read Full Answer >>
  5. How does covariance impact portfolio risk and return?

    Covariance provides diversification and reduces the overall volatility for a portfolio. Covariance is a statistical measure ... Read Full Answer >>
  6. How is correlation used in modern portfolio theory?

    Modern portfolio theory (MPT) emphasizes that investors can diversify away the risk of investment loss by reducing the correlation ... Read Full Answer >>

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