surplus efficient frontier

CFA Level III
#1

CFA reading 21, Blue boxes 14 and 15.

can anybody summarize conclusions to draw from these. i have never come across a question about them, but if CFAI spends that much ink, it must be worth understanding…

summerside, nvstn, baystreet? anybody??

#2

you mean example 9 and 10 ? never mind, got it. let me read it

#3

Maybe I can summarize the concept of a Surplus efficient frontier. This is actually one of the thing I do for a living.

A surplus efficient frontiere is done in a context of a ALM and monte carlo simulation. As you can see in Exhibit they chart the expected surplus giving a certain allocation.

What this means : you simulate both your asset and your liability for X years, then you see what is the surplus at the end of the simulation. Do 1000 economic simulation ( or wtv number ) with 1 portfolio asset allocation. When you have all 1000 ending value of the surplus ( asset- liability ) calculate the mean ( Y axis) and the variance ( X axis ) of the ending surplus at the end of your projection

test a new asset mix, and redoo the 1000 economic simulation.

once you have tested multiple asset mix, you can derive a efficient frontier of portfolio based on the average surplus and risk of the surplus. you plot them on a chart, and draw the frontier.

as you can see in exhibit 31 the portfolio 60/40 creates a 2 M$ surplus in average and has a standard divation of 15 M$. this means that in average you end up with a surplus of 2M but you can end up anywere in a normal distribution of u = 2m sigma = 15M with this 60/40 portfolio

so now you have incorporated the liability in your optimal portfolio since you are looking at the surplus. if the portfolio lies under the efficient frontier it means that you have more volatility on the surplus and a lower average surplus than what you can get with an optimal portfolio that lies on the efficient frontier.

hope this helps

#4

sounds good - pretty much what i got out of it but maybe tried to overthink it. t’es un bon gars, summerside! merci!

#5

pleasure, good luck for the exam and nice french. :slight_smile:

#6

i am a frenchie, lol!