Portfolio selection using mean‐risk model and mean‐risk diversification model

With mean‐risk and mean‐risk diversification models, return distributions are characterised and compared using two statistics: the expected value and the value of a risk measure. This paper uses mean‐risk model and risk curve obtained from the same model for portfolio selection problem. Security returns are assumed to be normally distributed. Further, the same mean‐risk model is modified by using entropy to diversify the risk; this model can be called as mean‐risk diversification model. In both the models, normal distribution is used to calculate the probability of likely losses of portfolio. The idea of mean‐risk model is to regard expected return of a portfolio as the investment return and risk curve thus formed as investment risk, and the idea of mean‐risk diversification model is to ensure that the portfolio thus formed is well diversified. The objective is to maximise the investor's return at a preset confidence level and minimise the risk. Two numerical examples are presented for the sake of illustration.