Would highly appreciate if someone could help me understand the graph
Hello Rick, hope this can help:
The Panel A is the result of mean variance optimization, one of the critiques of MVO is that the output is highly concebtrated asset allocation (5 asset classes in Panel A), Panel B corresponds to an asset allocation driven by reverse optimkzation or Black Litterman Model which uses the asset allocation as an input rather Than an output and that asset allocation is suposed to be optimal. So you can see that asset allocation in Panel B is more diversified.
The way you have to read each panel is standard deviation of returns (risk)in X axis and expected return in Y axis so is kind of tricky because the difference in colours is not so clear, each colour corresponds to an asset class.
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Note the vertical line in Panel B at a standard deviation of returns of about 11.3%. As you move up the line you see that the allocation to US Large Cap stocks is about 10%, the allocation to US Mid Cap stocks is about 5%, the allocation to US Small Cap stocks is about 2%, and so on. There are nine distinct asset classes in that allocation
Draw a similar vertical line in Panel A and compare that allocation to the one in Panel B. The former is much more concentrated than the latter, which has only four asset classes.
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