Portfolio Optimization and Diversification in China: Policy Implications for Vietnam and other Emerging Markets

Vo, Duc (2019): Portfolio Optimization and Diversification in China: Policy Implications for Vietnam and other Emerging Markets. Published in: Emerging Markets Finance and Trade (19 September 2019)

Abstract

This article is conducted to examine risk, return, and portfolio optimization at the industry level in China over the period 2007–2016. On the ground of the classical Markowitz framework for portfolio optimization, the mean-semivariance optimization framework is established for China’s stock market at the industry level. Findings from this study indicate that healthcare sector plays a significant role among 10 industries in China on a stand-alone basis. In addition, a significant change of rankings among the sectors in term of risk is found when the mean-semivariance optimization framework is used. We also find that utilizing this new framework helps improve the optimal portfolios in relation to performance, measured by Sortino ratio, and diversification. A simulation technique, generally known as resampling method, is also utilized to check the robustness of the estimates. While the use of this resampling method appears not to improve the performance of optimal portfolios compared with the mean-semivariance framework for China, there is a remarkable advance in diversification of the optimal portfolios. Implications for investors and the governments in Vietnam and other emerging markets have emerged from the study.

• Item Type: MPRA Paper
• Language: English
• Keywords: China, mean-semivariance, portfolio optimization, resample
• Subjects: G - Financial Economics > G2 - Financial Institutions and Services; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation

References

Allen, K. 2015. Why is China’s stock market in crisis? The Guardian, July8. https://www.theguardian.com/business/2015/jul/ 08/china-stock-market-crisis-explained

Asumeng-Denteh, E. 2004. Transaction costs and resampling in mean-variance portfolio optimization. Doctoral dissertation, Worcester Polytechnic Institute.

Ballestero, E. 2005. Mean-semivariance efficient frontier: A downside risk model for portfolio selection. Applied Mathematical Finance 12 (1):1–15. doi:10.1080/1350486042000254015.

Boasson, V., E. Boasson, and Z. Zhou. 2011. Portfolio optimization in a mean-semivariance framework. Investment Management and Financial Innovations 8 (3):58–68.

Campbell, R., R. Huisman, and K. Koedijk. 2001. Optimal portfolio selection in a Value-at-Risk framework. Journal of Banking 25 (9):1789–804. doi:10.1016/S0378-4266(00)00160-6.

Cardoso, J. N. M. 2015. Robust mean variance. Doctoral dissertation, Instituto Superior de Economia e Gestão.

Carpenter, J. N., F. Lu, and R. F. Whitelaw. 2015. The real value of China’s stock market. Cambridge, MA: National Bureau of Economic Research. https://www.nber.org/papers/w20957

Chen, X. X., and W. Z. Chen. 2007. Industry characteristics of correlations between China’s stock market and the major international markets. Shanghai Finance 2:52–55. (in Chinese).

Delcourt, F., and M. Petitjean. 2011. To what extent is resampling useful in portfolio management? Applied Economics Letters 18 (3):239–44. doi:10.1080/13504851003636123.

Drew, M. E., T. Naughton, and M. Veeraraghavan. 2003. Firm size, book-to-market equity and security returns: Evidence from the Shanghai stock exchange. Australian Journal of Management 28 (2):119.

Estrada, J. 2002. Systematic risk in emerging markets: The D-CAPM. Emerging Markets Review 3 (4):365–79. doi:10.1016/ S1566-0141(02)00042-0.

Estrada, J. 2004. Mean-semivariance behaviour: An alternative behavioural model. Journal of Emerging Market Finance 3 (3):231–48. doi:10.1177/097265270400300301.

Estrada, J. 2006. Downside risk in practice. Journal of Applied Corporate Finance 18 (1):117–25. doi:10.1111/jacf.2006.18.issue-1.

Estrada, J. 2007. Mean-semivariance behavior: Downside risk and capital asset pricing. International Review of Economics Finance 16 (2):169–85. doi:10.1016/j.iref.2005.03.003.

Estrada, J. 2008. Mean-semivariance optimization: A heuristic approach. Journal of Applied Finance 18 (1):57–72.

Fang, L., and D. A. Bessler. 2018. Is it China that leads the Asian stock market contagion in 2015? Applied Economics Letters 25 (11):752–57. doi:10.1080/13504851.2017.1363854.

Farrar, E. 1962. The investment decision under uncertainty, 90. Englewood Cliffs, New Jersey: Prentice-Hall, inc.

Fernandes, J. L. B., and J. R. H. Ornelas. 2009. Minimising operational risk in portfolio allocation decisions. Journal of Risk Management in Financial Institutions 2 (4):438–50.

Fernandez, P., J. Aguirreamalloa, and P. Linares. 2013. Market risk premium and risk free rate used for 51 countries in 2013: A survey with 6,237 answers.

Fletcher, J., and J. Hillier. 2001. An examination of resampled portfolio efficiency. Financial Analysts Journal 57:66–74. doi:10.2469/faj.v57.n5.2482.

Foo, T., and S. Eng. 2000. Asset allocation in a downside risk framework. Journal of Real Estate Portfolio Management 6 (3):213–23.

Galloppo, G. 2010. A comparison of pre and post modern portfolio theory using resampling. Global Journal of Business Research 4 (1):1–16.

Guo, P. F., and C. J. Yang. 2004. The industry characteristics of return, risk and corporate performance in Chinese stock market. Systems Engineering-Theory Methodology Application 04:320–23. (in Chinese).

Guo, X., C. Z. Niu, and W. K. Wong. 2019. Farinelli and Tibiletti ratio and stochastic dominance. Risk Management 21:201–13. doi:10.1057/s41283-019-00050-2.

Guo, X., X. J. Jiang, and W. K. Wong. 2017. Stochastic dominance and omega ratio: Measures to examine market efficiency. Arbitrage Opportunity, and Anomaly, Economies 5 (4):38.

Harlow, W. V. 1991. Asset allocation in a downside-risk framework. Financial Analysts Journal 47 (5):28–40. doi:10.2469/faj. v47.n5.28.

Harlow, W. V., and R. K. Rao. 1989. Asset pricing in a generalized mean-lower partial moment framework: Theory and evidence. Journal of Financial Quantitative Analysis 24 (3):285–311. doi:10.2307/2330813.

Harvey, C. R., J. C. Liechty, and M. W. Liechty. 2008. Bayes vs. resampling: A rematch. Journal of Investment Management 6:1.

He, H., S. Chen, S. Yao, and J. Ou. 2015. Stock market interdependence between China and the world: A multi-factor R-squared approach. Finance Research Letters 13:125–29. doi:10.1016/j.frl.2015.02.005.

Kohli, J. 2005. An empirical analysis of resampled efficiency. Worcester, MA: Worcester Polytechnic Institute.

Liu, X., and P. Sinclair. 2008. Does the linkage between stock market performance and economic growth vary across Greater China? Applied Economics Letters 15 (7):505–08. doi:10.1080/13504850500426277.

Ma, C., and W. K. Wong. 2010. Stochastic dominance and risk measure: A decision-theoretic foundation for VaR and C-VaR. European Journal of Operational Research 207 (2):927–35. doi:10.1016/j.ejor.2010.05.043.

Mansor, S. N. A., A. Baharum, and A. A. Kamil. 2006. Portfolio resampling in Malaysian equity market. Monte Carlo Methods Applications Mcma 12 (3):261–69. doi:10.1515/156939606778705146.

Markowitz, H. M. 1952. Portfolio selection. The Journal of Finance 7 (1):77–91. Markowitz, H. M. 1959. Portfolio selection: Eflicient diversi fication of investments. New York, NY: Yale University Press.

Markowitz, H. M. 1991. Foundations of portfolio theory. The Journal of Finance 46 (2):469–77. doi:10.1111/j.1540- 6261.1991.tb02669.x.

Markowitz, H. M., and N. Usmen. 2006. Resampled frontiers versus diffuse bayes: An experiment. In The world of risk management, ed. H. Gifford Fong, 183–202. USA: World Scientific.

Markowitz, H. M., P. Todd, G. Xu, and Y. Yamane. 1993. Computation of mean-semivariance efficient sets by the critical line algorithm. Annals of Operations Research 45 (1):307–17. doi:10.1007/BF02282055.

Metropolis, N., and S. Ulam. 1949. The Monte Carlo method. Journal of the American Statistical Association 44 (247):335–41.

Michaud, R. O. 1989. The Markowitz optimization enigma: Is ‘optimized’optimal? Financial Analysts Journal 45 (1):31–42. doi:10.2469/faj.v45.n1.31.

Michaud, R. O. (1998). Efficient asset management: A practical guide to stock portfolio management and asset allocation. Financial Management Association, Survey Synthesis Series. HBS Press, Boston, MA.

Niu, C. Z., W. K. Wong, and Q. F. Xu. 2017. Kappa ratios and (Higher-Order) stochastic dominance. Risk Management 19 (3):245–53. doi:10.1057/s41283-017-0020-1.

Perold, A. F. 1984. Large-scale portfolio optimization. Management Science 30 (10):1143–60. doi:10.1287/mnsc.30.10.1143.

Pla-Santamaria, D., and M. Bravo. 2013. Portfolio optimization based on downside risk: A mean-semivariance efficient frontier from Dow Jones blue chips. Annals of Operations Research 205 (1):189–201. doi:10.1007/s10479-012-1243-x.

Powell, R. J., D. H. Vo, and T. N. Pham. 2018. Economic cycles and downside commodities risk. Applied Economics Letters 25 (4):258–63. doi:10.1080/13504851.2017.1316818.

Shanghai Stock Exchange. 2017.

Shanghai stock exchange 2017 factbook. http://english.sse.com.cn/indices/publications/fact book/c/4389134.pdf

Sharpe,W.F.1964. Capital asset prices: Atheory of market equilibrium under conditions of risk. The Journal of Finance 19 (3):425–42. Sortino, F. A., and D. Hopelain. 1980. The pension fund: Investment, or capital budgeting decision. Financial Executive Magazine 48, 21–23.

Sortino, F. A., and L. N. Price. 1994. Performance measurement in a downside risk framework. The Journal of Investing 3 (3):59–64. doi:10.3905/joi.3.3.59.

Sortino, F. A., and R. Van Der Meer. 1991. Downside risk. The Journal of Portfolio Management 17 (4):27–31. doi:10.3905/ jpm.1991.409343.

Vo, D. H. 2015. Which factors are priced? An application of the Fama French three-factor model in Australia. Economic Papers 34 (4):290–301. doi:10.1111/1759-3441.12119.

Vo, D. H., T. N. Pham, T. V. Pham, L. M. Truong, and T. C. Nguyen. 2019. Risk, return and portfolio optimization for various industries in the ASEAN region. Borsa Istanbul Review 19 (2):132–38.

Wong, A., and X. Zhou. 2011. Development of financial market and economic growth: Review of Hong Kong, China, Japan, the United States and the United Kingdom. International Journal of Economics and Finance 3 (2):111. doi:10.5539/ijef. v3n2p111.

Xu, J., and S. Zhang. 2014. The Fama-French three factors in Chinese stock market. China Accounting and Finance Review 16 (2):210–27. doi:10.7603/s40570-014-0016-0. PORTFOLIO OPTIMIZATION AND DIVERSIFICATION IN CHINA 15

Yao, J., C. Ma, and W. P. He. 2014. Investor herding behaviour of Chinese stock market. International Review of Economics Finance 29:12–29. doi:10.1016/j.iref.2013.03.002.

Yu, H., L. Fang, B. Sun, and D. Du. 2018. Risk contribution of the Chinese stock market to developed markets in the post-crisis period. Emerging Markets Review 34:87–97. doi:10.1016/j.ememar.2017.10.006.

Zhang, G. M., and F. Y. Ren. 2006. Fluctuation characteristics of the industry sectors in China’s securities market. Statistics and Decision 1:99–100. (in Chinese).