The Efficient Frontier is a concept from modern portfolio theory that illustrates the set of optimal investment portfolios that offer the highest expected return for a given level of risk, or the lowest risk for a given level of expected return. It is represented graphically as a curve on a risk-return plot, where the x-axis denotes risk (typically measured by standard deviation) and the y-axis denotes expected return. Portfolios that lie on the Efficient Frontier are considered efficient, meaning that no other portfolio exists with a higher return for the same risk or lower risk for the same return.
Investors can use the Efficient Frontier to make informed choices about asset allocation by selecting portfolios that align with their individual risk tolerance. Mathematically, if represents expected return and represents risk (standard deviation), the goal is to maximize subject to a given level of or to minimize for a given level of . The Efficient Frontier helps to clarify the trade-offs between risk and return, enabling investors to construct portfolios that best meet their financial goals.
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