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ECO 426: Financial Economics

Professor Monica Tran-Xuan

Spring 2021

Project

Instructions: This project is designed to help you apply what you have learned about optimal

portfolio construction. You may use either Excel or Stata to complete the project. Regardless

of which software you use, you must document with images each step. Briefly explain your work

throughout the project: what is the purpose of the calculations you are doing? The main goal of

the project is for you to understand the theory behind optimal portfolio choice, as well as find good

data sources and become familiar with using statistical software.

Important: Your submissions should be in TWO files

One report file (Word, PDF, etc.) that should look and read like a short paper. In particular,

it should have an Introduction section, a Data section, a Results section etc. The report should

include tables and graphs. Please do not treat this as a Problem Set.

One data analysis file from the software that you used to generate your results (e.g., .xlsx

file for Excel, .do file for Stata, etc.)

Part II – Optimal Portfolio Construction

1. Using the estimates of expected returns, variances and covariances from part I, graph the

efficient frontier of the portfolio opportunity set using a software package.

2. Next, figure out the optimal weights we ought to place on each stock to form our optimal

risky portfolio. What is the expected return and variance of your optimal risky portfolio?

3. In the same graph as the efficient frontier, draw the Capital Allocation Line that goes through

the risk-free asset and the optimal risky portfolio.

4. In the same graph as the efficient frontier, fix a utility level and draw your indifference curve

that corresponds to that utility level. Draw multiple indifference curves until you draw the

one that is tangent to the Capital Allocation Line.

5. Recover the appropriate weights on the optimal risky portfolio and the risk-free asset that

correspond to the tangency between the indifference curve and the Capital Allocation Line.

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