Inefficient Portfolio

Posted in Finance, Accounting and Economics Terms, Total Reads: 332
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Definition: Inefficient Portfolio

When an investment portfolio does not give enough return for the risk taken for the investments the portfolio is defined as inefficient portfolio. Or in other words we can define an inefficient portfolio in which the combination of risky and risk-free asset does not lie on the efficient frontier.

 

Explanation

While designing a portfolio the main concern of the manager is to decide the weightage of different assets. Now, all the assets have their different risks and returns. The risk and return usually follows the traditional relation of ”higher the risk higher is the return” until and unless other factors comes into play. The risk of an investment is defined as the standard deviation (square root of variance) of that asset and when we find the covariance of two or more assets it can be either more or less than that of the individual variances.


This forms a relation between the risk and return of the portfolio with respect to the weightage of assets. Now the efficient frontier is defined as the combinations of weights for which the same amount of risk can be taken but the return will more.

 

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