Portfolio Selection in Indian Stock Market Using Relative Performance Indicator Approach
This chapter proposes a measure called Relative Financial Performance Indicator (RFPI) to identify and select stocks that are investment worthy. RFPI is obtained using Principal Component Analysis-Data Envelopment Analysis (PCA-DEA). The sample data consi
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Portfolio Selection in Indian Stock Market Using Relative Performance Indicator Approach Dhanya Jothimani, Ravi Shankar and Surendra S. Yadav
12.1
Introduction
A collection of various financial assets held by an investor is called portfolio. The investors hold a number of assets to diversify portfolio and to reduce risk. Portfolio optimization is a decision-making process where two or more conflicting objectives such as maximizing return and minimizing risks are considered. It involves three phases, namely, asset selection, asset allocation, and asset management. Asset selection refers to the process of selecting a collection of assets from same or different asset classes. The asset class includes stocks, real estate, and bonds. The process of asset allocation helps the investors to decide how much money can be invested in which asset(s) to reduce the risk and maximize the return. The final step, asset management helps the investors to evaluate the portfolio and define strategies to buy, sell, or hold an asset(s). The Mean-Variance (M-V) framework proposed by Markowitz (1952) to solve the portfolio optimization problem aims to find the “efficient frontier”, which consists of a combination of various assets that minimizes the risk at various levels of return or minimizes return at various levels of risk. The concept of portfolio optimization has been extended by various researchers (Doerner et al. 2004; Chang et al. 2009; Chen et al. 2009; Cura 2009; Lin and Ko 2009; Soleimani et al. 2009; Golmakani and Fazel 2011).
D. Jothimani (&) R. Shankar S.S. Yadav Department of Management Studies, Indian Institute of Technology (IIT) Delhi, Hauz Khas, New Delhi, India e-mail: [email protected] R. Shankar e-mail: [email protected] S.S. Yadav e-mail: [email protected] © Springer Nature Singapore Pte Ltd. 2018 Sushil et al. (eds.), Flexibility in Resource Management, Flexible Systems Management, DOI 10.1007/978-981-10-4888-3_12
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The standard M-V framework suffers from few limitations. Real-world data is not multivariate normally distributed as against assumed in M-V framework. The existing algorithms of quadratic program fail when constraints like bounding constraints and cardinality constraints are considered in the M-V framework (Maringer and Kellerer 2003; Singh et al. 2010). With remarkable increase in number of listings of companies on a stock exchange and accessibility and availability of various sources of information like financial statements, stocks prices, and economic conditions, it is challenging for the investors to screen and select the most profitable stocks. Evaluation and selection of appropriate assets are considered to be important processes since they influence asset allocation process. The scope of this chapter is limited to asset selection phase of portfolio optimization. The asset type considered is limited to stocks. The main focus of this chapter is to evaluate the financial performance of the firms using Relative Financial Performance Indicator (RFPI) and,
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