Constructing an optimal portfolio using Sharpe's single index model

Abstract

This paper attempts to construct an optimal portfolio by applying Sharpes Single Index Model of Capital Asset Pricing. Taking BSE 100 as market index and considering daily indices for the Oct02-April 03 period, the proposed method formulates a unique cut off point (Cut off rate of return) and selects stocks having excess of their expected return over risk-free rate of return surpassing this cut-off point. Percentage of investment in each of the selected stocks is then decided on the basis of respective weights assigned to each stock depending on respective b value, stock movement variance representing unsystematic risk, return on stock and risk free return vis-a-vis the cut off rate off return. Interestingly all the stocks selected turn out to be bank stocks.