The Complementarity Of Markov Chains Methodology And Markowitz Portfolio Optimization Model

Portfolio analysis and efficient investing have been in the center of attention of many investors for decades. The Markowitz model is the most famous concept of the Modern Portfolio Theory and it is very known both in domestic and foreign research. On the other hand, the Markov chain methodology is rarely used in the field of investing. Domestic research has neglected the aforementioned methodology, whilst the foreign research uses Markov chains in order to predict future movements of stock prices or returns. However, a link between two mentioned approaches to stock price (return) analysis does not exist. This paper is the first in this field, because it uses the results from Markov chain modeling while optimizing Markowitz model. An empirical analysis was performed on 26 stocks from the Zagreb Stock Exchange. The results show that although the diversification in terms of Markowitz is superior, the inclusion of other factors in analysis could enhance the predictive power of Markov chains methodology.