Diversification always reduces non-systematic risk within a portfolio to a certain extent. At the same time, selection of individual items or industry sector influences returns. Optimum portfolio selection within a capital market is primarily based on the best risk-return trade-off among the industry sectors. Literature suggests that much of market volatility can be attributed to substantial increase in sector specific and sub-sector specific risks. Performance of the economy influences industry sector returns differently and changes over time periods. Thus, changing pattern of correlations between sectors is vital for portfolio optimization purpose. The present study has estimated the dynamics of correlations of stock market returns between industry sectors in India using Asymmetric DCC GARCH model and tested efficient portfolios that generates returns above the market average. Use of Asymmetric DCC GARCH model helps in capturing the dynamics of correlations and as such a better estimate of the expected future correlations resulting in a portfolio that reflects future outcome more closely. If the risk adjusted returns of the industry selected portfolio is more than the index returns, we could argue that there is value in industry selection and accurate measurement of the correlations help generate these excess returns. Using daily market data for the period April 1997 to April 2007 on a sample of 10 industry sectors selected randomly indicates that investors can substantially improve their reward to risk as compared with the market returns. Sharpe ratio of the optimised portfolio improves to 0.994 (for optimised portfolio) from 0.527 (for S&P Nifty index).
|Number of pages||10|
|Journal||Delhi Business Review|
|Publication status||Published - 2008|