Kara Fisher is proposing changes to the current asset allocation of the New Frontier University Endowment. The Endowments current portfolio consists of two broad asset classes fixed income and global equity but Ms. Fisher is looking to expand into different asset classes. She has obtained historical returns, standard deviations, and correlations of the asset classes held currently as well as other asset classes being considered.

a) Ms. Fishers first approach is to use the mean-variance framework to obtain several optimal portfolios corresponding to different levels of risk tolerance.

Describe the major problem with the optimal weights that are typically obtained from the unconstrained mean-variance optimization approach.

Describe the concept of an equilibrium (that is, a neutral) asset allocation.

Explain how Ms. Fisher can adjust her estimates so that an equilibrium (that is, a neutral) asset allocation is obtained.

b) Ms. Fisher is seeking alternatives to mean-variance optimization. Compare the expected utility optimization approach of asset allocation to the mean-variance approach. Discuss two conditions related to utility functions or return distributions under which the two approaches would lead to the same asset allocation.