Methodology to design an efficient portfolio using Spearman and Kendall’s tau rank correlation coefficients

• Research Goal

• Development of a methodolgy to design an efficient portfolio
• Development of the relation between various industry sectors of  Dow Jones
  
  

• Research Statistics

• Research resource: 1 people
• Research term: 2008.8 ~ 2008.12 (5 months)
• My role responsible of this research: 100%
• Research output: Research Report
  
  

• Techniques used for this research

• Assumption:
• Consider only industry sector because economy is globally interacted and company is a minor factor.
• Use weekly data of Dow Jones sector index from 2000 to 2008
• Industry sector: Financial, Financial Service, Real Estate, Technology, Energy, Utility, Industrial, Telecommunication, Basic Material, Health care, Consumer Goods, and Consumer Service.
• Pick only two industry sectors even though investors could do many companies in them.
• Capital Asset Pricing Model(CAPM): CAPM is a model for pricing an individual security or a portfolio using systemic risk (beta). It shows how the market must price individual securities in relation to their security risk class. 

• Modern Portfolio Theory (MPT): It shows how rational investors will use diversification to optimize their portfolio, and how a risky asset should be priced. We could confirm that the small correlation between stock i and j is good at reducing the risk of portfolio. I will consider other methods using Spearman and Kendall’s tau correlation to apply this theory.

• Priority in investment (Hierarchy): 
• Economy: This is the most important factor in investment. For example, while economic cycle is in expansion, many companies and industries are increasing their values.
• Industry: It’s the second factor. 
• Company: It normally follows after economy and industry while the company has done well.
  
  

• Results

Figure1: Daily return of DJIA and portfolio 1(Technology + Consumer Goods)