Heuristic selection of portfolio based on coefficient of optimism

Abstract

The mean-variance method developed by Markowitz (1959) was aimed at obtaining optimizing portfolios. But selection of portfolio in the real world mostly deviates from this optimal criterion. In this paper we have considered this issue from an altogether different aspect and developed means for aiming at nearly optimum portfolio. We considered the risk taking propensity as the main driving force and presented a heuristic method to reach the near to the optimal state. For doing so, we have introduced the coefficient of optimism in the decision making process and simultaneously considered conditional optimum portfolio and corresponding heuristic portfolio. In the extreme situations three different human value systems can be considered as optimistic, pessimistic and risk planner. To examine the closeness between the heuristic and optimum portfolios we have carried out empirical analysis covering ten years data of fifteen companies from Nifty (2000-09). Regarding the choice of companies we have adopted random selection technique. From empirical study we have found that for moderate values of the coefficient of optimism a heuristic investor’s decision nearly coincides with the corresponding optimum portfolio. However, for extreme situations i.e. optimistic and pessimistic situations heuristic portfolio differs from optimum portfolio. Keywords: Expected return, risk, optimum portfolio, heuristic portfolio, coefficient of optimism.