Risk/return diagram

When optimizing the return of the portfolio, risk has to be taken into account. Within a shortfall risk approach the portfolio is optimal that falls short of a user specified minimum return (e.g., r, in = 0%) with a given shortfall probability p (e.g., 10%). A very risk averse investor requires a higher minimum return and a lower shortfall probability than a less risk averse one. Exhibit 27.2 displays this graphically in the risk/ return diagram. 

Equation (27.2) describes a line with slope k starting from point Q in the risk/return diagram (Exhibit 27.2)7 Maximization of the expected portfolio return in equation (27.1) in compliance with equation (27.2) exactly describes the investor s risk aversion. Additionally, the following collateral conditions are set ... 

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