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Exact Solution for the Portfolio Diversification Problem Based on Maximizing the Risk Adjusted Return

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  • Abdulnasser Hatemi-J
  • Mohamed Ali Hajji
  • Youssef El-Khatib

Abstract

The potential benefits of portfolio diversification have been known to investors for a long time. Markowitz (1952) suggested the seminal approach for optimizing the portfolio problem based on finding the weights as budget shares that minimize the variance of the underlying portfolio. Hatemi-J and El-Khatib (2015) suggested finding the weights that will result in maximizing the risk adjusted return of the portfolio. This approach seems to be preferred by the rational investors since it combines risk and return when the optimal budget shares are sought for. The current paper provides a general solution for this risk adjusted return problem that can be utilized for any potential number of assets that are included in the portfolio.

Suggested Citation

  • Abdulnasser Hatemi-J & Mohamed Ali Hajji & Youssef El-Khatib, 2019. "Exact Solution for the Portfolio Diversification Problem Based on Maximizing the Risk Adjusted Return," Papers 1903.01082, arXiv.org.
  • Handle: RePEc:arx:papers:1903.01082
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    File URL: http://arxiv.org/pdf/1903.01082
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    References listed on IDEAS

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    1. Jorion, Philippe, 1985. "International Portfolio Diversification with Estimation Risk," The Journal of Business, University of Chicago Press, vol. 58(3), pages 259-278, July.
    2. 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.
    3. Hatemi-J, Abdulnasser & El-Khatib, Youssef, 2015. "Portfolio selection: An alternative approach," Economics Letters, Elsevier, vol. 135(C), pages 141-143.
    4. 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.
    5. 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.
    6. 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.
    7. 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.
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    Cited by:

    1. Abdulnasser Hatemi-J & Mohamed A. Hajji & Elie Bouri & Rangan Gupta, 2019. "The Benefits of Diversification between Bitcoin, Bonds, Equities and the US Dollar: A Matter of Portfolio Construction," Working Papers 201959, University of Pretoria, Department of Economics.

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