Abstract
Cointegration approach to the passive portfolio management enables to replicate the selected stock index and to construct a portfolio with profitability and risk similar to market. This paper analyzes several options for improving this method. It focuses on one of the key tasks, which is an estimate of long-run equilibrium relationship. Five different methods were proposed and compared. The results confirmed the relevance of using the Engle-Granger methodology in all previous surveys, but it also suggested some interesting properties related to the estimate of regression coefficients based on different variants of the Minkowski metric or to estimate regression equation without intercept.
Highlights
The traditional construction of a financial portfolio is based on an analysis of the correlation structure among the particular financial assets involved in the portfolio
This paper is focused on comparison of portfolios created with an intention of index tracking based on cointegration and with a long-run equilibrium relationship estimated by five different ways
In addition to frequently used estimate of cointegrating vector by Ordinary least squares (OLS), we have considered omitting an intercept in the regression model and estimating based on two different parameters of Minkowski metric (k = 1, 5)
Summary
The traditional construction of a financial portfolio is based on an analysis of the correlation structure among the particular financial assets involved in the portfolio. It was Harry Max Markowitz (1952) in early 1950’s who published a revolutionary paper on how does one select an efficient set of risky investment or so called efficient frontier. This theory provides the first quantitative view of portfolios variance, where co-movements in securities returns are considered. In general the use of the traditional concept is delimited and depends on the level of change within the portfolio volatility
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