Journals Information
Universal Journal of Accounting and Finance Vol. 10(2), pp. 624 - 634
DOI: 10.13189/ujaf.2022.100227
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The Effect of Market Factor on Portfolio Selection
Daniel Arficho Gaenore 1,*, M Montaz Ali 2, Aduda Jane Akinyi 3
1 Department of Statistics and Actuarial Sciences, Faculty of mathematics, Pan African University for Basic Sciences, Technology and Innovations, Nairobi, Kenya
2 School of Computer Science and Applied Mathematics, University of the Witwatersrand, Johannesburg, South Africa
3 Department of Statistics and Actuarial Sciences, Faculty of mathematics, JKUAT, Nairobi, Kenya
ABSTRACT
Investors' attempt is to allocate scarce resources today and receive the best outcome in future. The best outcome in future is not known today. But one can forecast for the best outcome in future today. Markowitz developed mean-variance model to solve portfolio selection problem. This model has two main drawbacks. The first is that the model assumes future expected return is the same as current expected return. In practice, this assumption may not hold in general. The second drawback is that the model requires a lot of estimations when investors consider large number of assets to include in portfolio. Sharpe developed single index model to solve the second drawback of mean-variance model. In this research, we develop future portfolio model to deal with drawbacks of mean-variance model. The objective of future portfolio model is to maximize future Sharpe ratio forecast subject to no short and no leftover constraints. This model is a realistic model because investors would like to consider future outcome instead of current outcome. First, we construct future expected return forecast model to forecast future expected return of securities. Second, we apply capital asset pricing model to estimate variance of portfolio. Third, we build future portfolio model using future expected return forecast model and capital asset pricing model. Fourth, we solve for analytic solution of future portfolio model. Finally, we evaluate the performance of future portfolio model relative to single index portfolio based on Sharpe ratio process metric, diversification ratio process metric and accumulation factor error process metric. The result of this study shows that future portfolio outperforms single index portfolio based on Sharpe ratio process metric, diversification ratio process metric and accumulation factor error process metric except at few instant time points.
KEYWORDS
Accumulation Factor, Arbitrage, Forecast, Model, Sharpe Ratio
Cite This Paper in IEEE or APA Citation Styles
(a). IEEE Format:
[1] Daniel Arficho Gaenore , M Montaz Ali , Aduda Jane Akinyi , "The Effect of Market Factor on Portfolio Selection," Universal Journal of Accounting and Finance, Vol. 10, No. 2, pp. 624 - 634, 2022. DOI: 10.13189/ujaf.2022.100227.
(b). APA Format:
Daniel Arficho Gaenore , M Montaz Ali , Aduda Jane Akinyi (2022). The Effect of Market Factor on Portfolio Selection. Universal Journal of Accounting and Finance, 10(2), 624 - 634. DOI: 10.13189/ujaf.2022.100227.