The Application of Two-Stage Diversification to Portfolios from the WSE

Abstract

Diversification is one of the most important elements of the process of investment portfolio management. The special attention is focus on the diversification in the periods of the rapid changes in the financial markets. The numerous empirical research have shown that the lack of the appropriate assumptions in the portfolio construction or the bad stock selection can have catastrophic consequences. One of the important problem is the portfolio diversification. In the recent years a few interesting methods to construct the well-diversified portfolios have been proposed. In the article the models of construction the Rao’s Quadratic Entropy portfolios and the Most Diversified Portfolios were described. Also two criteria for selecting stocks to portfolio were presented. These criteria in some sense can improve the well-diversified portfolios. Proposed methods were applied to selected stocks from the Warsaw Stock Exchange. The main goal of these research was analysis of the impact of presented criteria on the risk, rate of return and Sharpe Ratio of diversified portfolios. The research provided that the best results were received when the stocks were selected according to the values of Portfolio Diversification Index and when portfolios were constructed as the Most Diversified Portfolios.