APPLICATION OF PORTFOLIO OPTIMIZATION: A STATISTICAL APPROACH
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Nigeria stock market is a place where investors buyshares of assets or securities mostly for them to earn reward (returns) at a given level of „tolerable‟ risk. The word „portfolio‟ is used to mean a mix or combinatory pool of assets, securities or investment of financial or physical nature, in which an investor holds to meet his/her set objectives. On the other hand, portfolio selection is choosing the most suitable combination of assets by risk averse or rational investor to maximize return while at the same time minimizes risk.
Due toabrupt unpleasant surprises of global financial crisis, and inferior market downturn experienced by financial markets in different times, investors are becoming highly concerned about the risk of their investments coupled seeking ways to achieve more attractive risk/return characteristics and better capital protection in difficult environments. The main plan of portfolio management is to form diverse securities in a portfolio that meets the needs of investors and thereafter manage the portfolio in other to obtain required goals (Vigdiset al., 2011). Many players in the financial market have been frequently looking for strategic ways of investing which is capable of meeting this aforesaid protest of the market.
Modern Portfolio Theory(MPT) pioneered by Markowitz (1952, 1970, 1987) seminal work specifically solves the tradeoff between risk and return using formed curve in graph called efficient frontier. This frontier solves the problem by considering the risk, return of invested assets and the correlation that exist between the asset return. The curve identifies those that are at maximum return for a given level of risk, or at their minimum risk for a given level of return.
Markowitz‟s work to a great extent changes the behavior of investors and financial managers by providing more insight on the issue of assets selection. Nowadays, players in the market are embracing the framework viewed as the most standard model for today‟s investment management even with the model‟s unrealistic questionable assumptions.
Markowitz (1991), as well asElton and Gruber (1997) talk more on the main issue an investor faces when investing, of them is how to distribute resources among different assets alternatives. Almost all investors are being posed with this same problem, with the added sufferings and complications needed to clearly include the properties of the liabilities in the analysis (Bodieet al. 2004). The problems are different in terms of structure, but that can be categorized to the portfolio theory.
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APPLICATION OF PORTFOLIO OPTIMIZATION: A STATISTICAL APPROACH
