Abstract
Currently, there are a lot of criticisms on Modern Portfolio Theory (MPT). Black Swan argument claims that in the event of a financial turmoil, the stock prices move beyond what is expected by normal distribution. This study empirically investigates whether it is possible to apply MPT by using additional criteria. The criteria used in this research are related to financial analysis, a well-known field in corporate finance. The ratios used are debt-to-equity and return on equity. According to the analysis, Modern portfolio theory can be applied by the use of these additional criteria. The analysis with debt-to-equity criterion reveals that Portfolios 3 and 5 which have lower debt-to-equity ratios performed better in the period. The analysis with return on equity reveals that only Portfolio 8 which has 9 companies with ratios larger than 0.2 has positive return whereas the other portfolios have negative returns. The results further show that, while applying MPT with these criteria is perfectly possible and sound, the investor could diversify further by selecting portfolios with higher number of securities and still have better financial ratios. This research to the authors' knowledge brings a novelty by proposing these selection criteria in MPT. The suggested method could be applied by practitioners in this field. This study also targets to bring a new direction to the ongoing debate whether the theory of Markowitz (commonly known as father of Modern Portfolio Theory) is dead or alive.
Highlights
A wise investor doesn’t will to risk all of his/her wealth by investing all his and wealth in single asset class
This study has an empirical analysis on Istanbul Stock Exchange, ISE 30 which is an index on 30 bluechip stocks
Efficient portfolios could be selected when financial analysis based selection criteria is added to Modern Portfolio Theory (MPT)
Summary
A wise investor doesn’t will to risk all of his/her wealth by investing all his and wealth in single asset class. Mathematical foundations of what we today call modern portfolio theory are given by Markowitz (1952). Some of these computations are available in the methodology section of this study. It is possible to determine an efficient portfolio given previous returns, variances, and covariances of different asset clases. There are many studies which used mean variance optimization (MVO) in Istanbul Stock Exchange. The method of Markowitz is mean variance optimization. This means, he used mean for return and variance for risk. In this study standard Modern Portfolio Theory procedure is followed but it is perfectly possible to use other measurements for risk such as Value at Risk. Closing prices of stocks in ISE30 and ISE100 (these are the bluechip indices in Istanbul Stock exchange) indices are used in this study
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