Asset management : finding the optimal portfolio using econometric variables

Abstract

After a lengthy literature review regarding the optimal portfolio and possible indicators which could be used to help investors to construct such portfolios, it was identified that it is possible to make use of econometric variables in order to help guide individuals to find the optimal allocation of stocks and bonds to reap the highest possible yield. In this thesis an econometric model shall be constructed using these economic indicators in order to come up with an ultimate indicator which will determine the allocation of stocks and bonds one should have in his/her portfolio. This study will first be implemented for the period ranging from 1980 until 2010 for the US market, and from 1986 until 2010 for the UK and German markets. Following the first analysis, the hypothesis will be further tested during the period starting 2011 and ending 2018 to determine whether the econometric model constructed yields the wanted results. The purpose of the first part of the analysis is to see how the econometric model performed during the 24/30 year period ending in 2010. After the model is constructed, the movements will be compared to the historic cycles of each economy and if the models correspond with these cycles then following the econometric model strategy to invest should be the optimal strategy for investors. The model should display downward trends in times of recession and upward trends in times of economic growth. Following the analysis to ensure that the model follows the historic economic cycles of each economy, calculations will be made in order to test the performance of the econometric model strategy in comparison to 3 other static allocation strategies. These calculations will be carried out from 2011 until 2018 and will be conducted by assuming that a principal of 100,000 will be invested at the beginning of each period for each strategy, and this sum will be divided amongst stocks and bonds depending on the allocation indicated by each strategy. The performance of each strategy will then be compared in order to see whether following the econometric model strategy is the best way forward or no.