Stock portfolio selection based on investors' risk preference

Abstract

Stock portfolio investment gives investors the opportunity to engage in diversification among stocks which helps to achieve higher financial risk-adjusted return. A properly diversified stock portfolio should include stocks that have different economic variable such as interest rate, exchange rate and share price. It helps investors to achieve higher risk-adjusted return, nevertheless there are investors who love risk known as Risk Premium investors and Risk Averse investors who prefer lower risk. The risk value of stocks acts as an indicator in selecting stocks to be included in a portfolio. Risk value of stock portfolios is used in selecting stock portfolio that follows investors' risk preference. This study forecast share price by using Geometric Brownian Motion and hence use the Variance Covariance to calculate Value at Risk of each stock and stock portfolio in future investment. The stock portfolios in this study are based on five sectors which are industrial-product, consumer, construction, technology, and trading and services. Thus, there are five stock portfolios that are produced for each type; Risk Averse and Risk Premium investors. Using the Value at risk of each stock portfolio, it is found that Stock portfolio from the Industrial Product Trading and Service sectors is the most suitable for Risk Averse and Risk Premium investors respectively. This study may serve as a guide for investors in creating and choosing stock portfolios for future investment based on their risk preference and also forecast its Value at Risk.