Single index model+portfolio construction

durch  |  22-Dec-2016 07:12

Single index model+portfolio construction
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The study aimed at applying Sharpe's single index model for constructing an optimal portfolio and understanding the effect of diversification of investments.

The study is empirical in nature and is based on secondary data.

Single index model+portfolio construction-61

Single index model+portfolio construction

He made the numerous and complex computations easy, which were essential to attain optimal portfolio.

This simplification is achieved through single index model proposed by Sharpe considered as the simplest and the most widely used one.

Assume the risk free rate of return as 5 per cent and the standard deviation of the market return as 25 per cent.

Solution: The selection of the portfolio from these securities will be by building the following table.

The table ranks the securities on the basis of the Sharpe measure of excess returns relative to beta risk: Columns: (1) (Ri – Rf) (2) (Βi/σei2) (3) (1)*(2) (4) Cumulative of column 3 values (5) σm2 * (4) (6) (Βi2/σei2) (7) Cumulative of column 6 values (8) 1 [σm2 * (7)] (9) Ci = (5)/ (8)The ranking of securities on the basis of their risk related returns is then followed by the computation of Ci for a portfolio of the combined securities.

Single index model+portfolio construction

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