PORTFOLIO CHOICE WITH A FUNDAMENTAL CRITERION – AN ALGORITHM AND PRACTICAL APPLICATIONON – A COMPUTATION METHODS AND EMPIRICAL ANALYSIS

Abstract

Classical models for the construction of an investment portfolio do not account for the fundamental values of the companies considered. In our approach, we extend portfolio choice by adding a new criterion connected with the fundamental values of companies to the classical criteria of expected return and risk. It is assumed that an investor selects stocks according to their attractiveness, measured by indicators of the economic and financial situation of companies. In this approach, portfolios are assessed according to three criteria: expected returns, risk (measured by the variance of returns), and the economic situation of the companies (measured by selected indicators). In this article, we consider the book-to-price ratio as a measure of the fundamental value of a company. We discuss an algorithm for constructing portfolios with this fundamental value criterion based on analytical solutions for relevant optimization problems. In the optimization problem, we consider minimizing variance with constraints on expected return and attractiveness of investment. We also present empirical examples of calculating efficient portfolios of stocks listed on the Warsaw Stock Exchange and compare their performance with efficient portfolios built according to the classical Markowitz approach. By adding an additional criterion of the book-to-market value, we obtain portfolios with a higher average realized rate of return compared with the classical Markowitz model. Thus, it can be useful for investors in the capital market to incorporate an additional criterion connected with the fundamental values of companies when preparing a model of stock returns.

Data:
Received: 31 Mar 2021
Revised: 23 May 2021
Accepted: 6 Jun 2021
Published: 20 Jun 2021