Sector Analysis and Portfolio Optimisation: The Indian Experience

Abstract

With changing global financial environment and emergence of new economic powers in recent decades, diversification of investment portfolios at country and sector levels assumed additional significance. Optimum portfolio selection within a capital market is primarily based on the best risk-return trade-off among the industry sectors. Literature suggests that much of market volatility can be attributed to substantial increase in sector specific and sub-sector specific risks. This research has estimated the dynamics of correlations of stock market returns between industry sectors in India using Asymmetric DCC GARCH model and tested efficient portfolios that generates returns above the market average. Analysis of daily and monthly market data for the period April 1997 to April 2007 on a sample of 10 industry sectors selected randomly indicates that investors can substantially improve their reward to risk as compared with the market returns. Major contributions of this research are two fold. It used a computationally efficient model for estimating correlations that can incorporate the changes in correlations over time and it applied the model for the Indian market where research is extremely inadequate.