A Simulation Package in VBA to Support Finance Students for Constructing Optimal Portfolios

TL;DR

This paper presents a VBA-based software tool that helps finance students construct optimal portfolios using traditional and risk-return optimized methods, including an exhaustive search for the best asset combination.

Contribution

The software uniquely constructs all possible asset combinations to empirically identify the optimal portfolio, a feature often neglected in existing literature.

Findings

Supports Markowitz and risk-return optimization methods

Constructs all asset combinations for empirical selection

Includes a user-friendly graphical interface

Abstract

This paper introduces a software component created in Visual Basic for Applications (VBA) that can be applied for creating an optimal portfolio using two different methods. The first method is the seminal approach of Markowitz that is based on finding budget shares via the minimization of the variance of the underlying portfolio. The second method is developed by El-Khatib and Hatemi-J, which combines risk and return directly in the optimization problem and yields budget shares that lead to maximizing the risk adjusted return of the portfolio. This approach is consistent with the expectation of rational investors since these investors consider both risk and return as the fundamental basis for selection of the investment assets. Our package offers another advantage that is usually neglected in the literature, which is the number of assets that should be included in the portfolio. The common practice is to assume that the number of assets is given exogenously when the portfolio is constructed. However, the current software component constructs all possible combinations and thus the investor can figure out empirically which portfolio is the best one among all portfolios considered. The software is consumer friendly via a graphical user interface. An application is also provided to demonstrate how the software can be used using real-time series data for several assets.