Three-Asset Efficient Frontier

μ

1

0.14

σ

1

0.05

μ

2

0.1

σ

2

0.15

μ

3

0.5

σ

3

0.2

ρ

12

0.2

ρ

13

-0.2

ρ

23

-0.1

Consider three assets with expected returns

μ

i

and standard deviations of returns

σ

i

; i = 1, 2, 3. Let the correlation coefficient between asset i and asset j be

ρ

ij

. Each blue point represents the expected return and the standard deviation of return of a portfolio created by a specific combination of the three assets. The orange line, known as the efficient frontier, sketches out the portfolio combinations such that for any expected return, the volatility (or standard deviation of return) is the lowest; and for any level of volatility, the expected return is the highest.