Constructing Optimal Equity Portfolio of Large Cap Companies using Sharpe’s Single Index Model

Abstract

Portfolio construction is an important process of the investors for investment in the equity market. A good combination of a portfolio will give maximum return for a particular level of risk. This research tries to construct an optimal portfolio in Indian stock market with the help of the Sharpe’s single index model. In this research, top 10 stocks of Nifty have been selected on the basis of their market capitalization. The monthly data for all the stocks for the period of April 2010 to December 2016 have been considered. The proposed method formulates a unique cut-off rate and selects those securities to construct an optimal portfolio whose excess return to beta ratio is greater than the cut-off rate. Then, the proportion of investment in each of the selected securities is computed on the basis of beta value, unsystematic risk, and excess return to beta ratio and cut-off rate of each of the securities concerned. The study finds that four company stocks constitute the optimum portfolio and these are TCS, HUL, ITC, and HDFC bank with ideal proportion of investment of 31%, 30%, 27% and 12% respectively.

Keywords: Beta, Portfolio Construction, Optimal Portfolio, Systematic Risk and Unsystematic Risk.