Portfolio selection based on an volatility measure adjusted for irrationality
DOI:
https://doi.org/10.14738/abr.76.6732Keywords:
Irrationality, Volatility, Portfolio Selection, Portfolio ManagementAbstract
This paper investigates the combination of the two risk measures irrationality and volatility for portfolio selection as well as irrationality as a standalone risk measure. The study is conducted for a period of 20 years, ranging from 1999-01-04 to 2018-12-31, using daily closing prices from 1.295 stocks. The companies are derived from the indices S&P 500, STOXX 600 and a representative index of the German market out of the indices DAX, MDAX, SDAX and TecDAX. The findings indicate a negative relationship between risk and return in terms of irrationality across the three indices. The effect is particularly evident when comparing the portfolios with the lowest and highest values of irrationality. Further, the analysis provides an indication of how an index can be replicated with fewer expenses and complexity, particularly regarding the fact that the volatility of the synthetic portfolio is equivalent.
References
2. Sharpe, W.F. Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk. The journal of finance 1964, 19, 425–442, doi:10.2307/2977928.
3. Lintner, J. The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets: A Reply. The Review of Economics and Statistics 1969, 51, 222–224, doi:10.2307/1926735.
4. Roll, R. A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory. Journal of financial economics 1977, 4, 129–176.
5. Black, F.; Jensen, M.C.; Scholes, M. The capital asset pricing model: Some empirical tests. Studies in the theory of capital markets 1972, 81, 79–121.
6. Fama, E.F.; French, K.R. The Capital Asset Pricing Model: Theory and Evidence. Journal of economic perspectives 2004, 18, 25–46.
7. Schädler, T. Measuring Irrationality in Financial Markets. Archives of Business Research 2018, 6, 252–259, doi:10.14738/abr.612.5876.
8. Shiller, R.J. Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends? The American Economic Review 1981, 71, 421–436.
9. Appel, D.; Grabinski, M. The origin of financial crisis: A wrong definition of value. Portuguese Journal of Quantitative Methods 2011, 3, 33–51.
