Abstract
The paper aims at constructing an optimal portfolio by applying Sharpe’s single index model of capital asset pricing in different scenarios, one is ex ante stock price bubble scenario and stock price bubble and bubble burst is second scenario. Here we considered beginning of year 2010 as rise of stock price bubble in Dhaka Stock Exchange. Hence period from 2005 -2009 is considered as ex ante stock price bubble period. Using DSI (All share price index in Dhaka Stock Exchange) as market index and considering daily indices for the March 2005 to December 2009 period, the proposed method formulates a unique cut off point (cut off rate of return) and selects stocks having excess of their expected return over risk-free rate of return surpassing this cut-off point. Here, risk free rate considered to be 8.5% per annum (Treasury bill rate in 2009). Percentage of an investment in each of the selected stocks is then decided on the basis of respective weights assigned to each stock depending on respective ‘β’ value, stock movement variance representing unsystematic risk, return on stock and risk free return vis-à-vis the cut off rate of return. Interestingly, most of the stocks selected turned out to be bank stocks. Again we went for single index model applied to same stocks those made to the optimum portfolio in ex ante stock price bubble scenario considering data for the period of January 2010 to June 2012. We found that all stocks failed to make the pass Single Index Model criteria i.e. excess return over beta must be higher than the risk free rate. Here for the period of 2010 to 2012, the risk free rate considered to be 11.5 % per annum (Treasury bill rate during 2012).
Highlights
A fundamental question in finance is how the risk of an investment should affect its expected return
One of the assumptions behind the Capital Asset Pricing Model (CAPM) is that investors agree on the expected rates of the return and the risks that they bear
Debasish Dutt (1998) found that all the stocks selected are bank stocks. He used Sharpe single index model in order to optimize a portfolio of 31 companies from BSE (Bombay Stock Exchange) for the period October 1, 2001 to April 30, 2003 and used BSE 100 as market index
Summary
A fundamental question in finance is how the risk of an investment should affect its expected return. The principle of diversification seeks to place all the eggs in different baskets and to keep entire investment in a single asset would be unwise and risky. This gives rise to the idea of portfolio. Portfolio management means construct portfolios with suitable allocation of assets in order to reach investor's return objectives, while valuing the investor's constraints in term of risk and asset allocation. The idea behind the model is that an investor cannot increase its expected return without increasing the risk of the portfolio. One of the assumptions behind the CAPM is that investors agree on the expected rates of the return and the risks that they bear. Markowitz established that the risk of a portfolio is lower than the average of the risks of each asset taken individually and gave quantitative evidence of the contribution of diversification
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
