International Diversification

Description

Attached are monthly returns for country portfolios, specifically the G7. The average monthly risk-free rate over this time period is 0.07%. The objective of this exercise is to apply portfolio theory to real financial data and gain a better understanding of 1) why securities are optimally chosen in a portfolio and 2) what are economic drivers of diversification.

Directions

1. Begin the assignment by assigning an investment weight of 14% in each country. Use =sum() to calculate the sum of the investment weights for the portfolio.
2. Using the investment weights, calculate the portfolio returns.
3. Calculate the average, standard deviation, and Sharpe ratio for each country and the portfolio.
4. Calculate correlation matrix of the G7 countries.
5. Using Solver, solve for the optimal investment weights that maximize the portfolio's Sharpe ratio.
6. Replicate the plot below by plotting the optimal investment weights against the country Sharpe ratios.


Questions

  1. What are the optimal investment weights for Japan and the US?
  2. Explain the economic reasoning for why Solver choose these specific optimal investment weights.

Solutions