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Portfolio selection: An alternative approach

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  • Hatemi-J, Abdulnasser
  • El-Khatib, Youssef

Abstract

This paper provides a solution to the portfolio diversification problem based on finding optimal weights that will result in maximizing the risk adjusted return of the underlying portfolio subject to the budget constraint contrary to the standard approach that aims at finding the required weights based on minimizing the variance of the portfolio subject to the budget constraint. A mathematical proof is given for the suggested solution. An application is provided to the portfolio diversification opportunity between all the share market indexes of the two largest economies in the world. The results show that the portfolio created by our suggested approach leads to almost one percent increase in the risk adjusted return compared to the portfolio created by the standard method.

Suggested Citation

  • Hatemi-J, Abdulnasser & El-Khatib, Youssef, 2015. "Portfolio selection: An alternative approach," Economics Letters, Elsevier, vol. 135(C), pages 141-143.
    • Handle: RePEc:eee:ecolet:v:135:y:2015:i:c:p:141-143
    DOI: 10.1016/j.econlet.2015.08.021
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    References listed on IDEAS

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    1. De Santis, Giorgio & Gerard, Bruno, 1997. "International Asset Pricing and Portfolio Diversification with Time-Varying Risk," Journal of Finance, American Finance Association, vol. 52(5), pages 1881-1912, December.
    2. Hatemi-J, Abdulnasser & Roca, Eduardo, 2006. "A re-examination of international portfolio diversification based on evidence from leveraged bootstrap methods," Economic Modelling, Elsevier, vol. 23(6), pages 993-1007, December.
    3. Klein, Roger W. & Bawa, Vijay S., 1977. "Abstract: The Effect of Limited Information and Estimation Risk on Optimal Portfolio Diversification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(4), pages 669-669, November.
    4. Jorion, Philippe, 1985. "International Portfolio Diversification with Estimation Risk," The Journal of Business, University of Chicago Press, vol. 58(3), pages 259-278, July.
    5. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, March.
    6. Klein, Roger W. & Bawa, Vijay S., 1977. "The effect of limited information and estimation risk on optimal portfolio diversification," Journal of Financial Economics, Elsevier, vol. 5(1), pages 89-111, August.
    7. Aase, Knut Kristian, 1984. "Optimum portfolio diversification in a general continuous-time model," Stochastic Processes and their Applications, Elsevier, vol. 18(1), pages 81-98, September.
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    Citations

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    Cited by:

    1. Youssef El-Khatib & Abdulnasser Hatemi-J, 2023. "On a regime switching illiquid high volatile prediction model for cryptocurrencies," Journal of Economic Studies, Emerald Group Publishing Limited, vol. 51(2), pages 485-498, July.
    2. Abdulnasser Hatemi-J & Mohamed A. Hajji & Elie Bouri & Rangan Gupta, 2022. "The Benefits of Diversification Between Bitcoin, Bonds, Equities and the US Dollar: A Matter of Portfolio Construction," Asia-Pacific Journal of Operational Research (APJOR), World Scientific Publishing Co. Pte. Ltd., vol. 39(04), pages 1-11, August.
    3. Migliavacca, Milena & Goodell, John W. & Paltrinieri, Andrea, 2023. "A bibliometric review of portfolio diversification literature," International Review of Financial Analysis, Elsevier, vol. 90(C).
    4. Hatemi-J, Abdulnasser & Taha, Viyan, 2021. "Portfolio Diversification Benefits between Financial Markets of the US and China: Empirical Evidence from two Alternative Methods," Economia Internazionale / International Economics, Camera di Commercio Industria Artigianato Agricoltura di Genova, vol. 74(4), pages 537-546.
    5. Hatemi-J, Abdulnasser & Hajji, Mohamed Ali & El-Khatib, Youssef, 2022. "Exact solution for the portfolio diversification problem based on maximizing the risk adjusted return," Research in International Business and Finance, Elsevier, vol. 59(C).
    6. Yue Wang & Zhijian Qiu & Xiaomei Qu, 2017. "Optimal portfolio selection with maximal risk adjusted return," Applied Economics Letters, Taylor & Francis Journals, vol. 24(14), pages 1035-1040, August.
    7. Liu, Weiyi, 2019. "Portfolio diversification across cryptocurrencies," Finance Research Letters, Elsevier, vol. 29(C), pages 200-205.
    8. Abdulnasser Hatemi-J & Alan Mustafa, 2023. "A Simulation Package in VBA to Support Finance Students for Constructing Optimal Portfolios," Papers 2305.12826, arXiv.org.
    9. Abdulnasser Hatemi-J, 2024. "An Asymmetric Capital Asset Pricing Model," Papers 2404.14137, arXiv.org, revised May 2024.

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    More about this item

    Keywords

    Portfolio diversification; Optimization; Return and risk;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling

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