Maximizing the Returns While Minimizing the Risk using Sharpe's Ratio

Abstract

The Linear Programming model structure gives an efficient framework to construct a portfolio. The variables in this framework are the weights assigned to each security included in the portfolio. This framework can accommodate only one objective and the natural choice of the investors will be to maximize the return. But the optimum solution for the problem obtained with this objective will be invariably associated with maximum risk. It is because the Risk and the Return move together. Hence maximizing the returns may not be a suitable objective for a risk averting investor. Instead minimizing the risk may be an ideal objective for the risk averting investors. But with this objective, the returns will also be minimum. Hence this study focuses on identifying an appropriate objective for the risk averting investors. The study attempts to maximize the Sharpe’s Ratio and concludes that this objective has more credibility than the objective of minimizing the risk.