A Comparative Technical Portfolio Return-risk Analysis In A Segmented Equity Market--- A Case Of Nairobi Stock Exchange: 2001-2005
The study focused on comparative evaluation of portfolio analysis models of Modern Portfolio Theory and Capital Asset Pricing Model using historical data of stock prices, trading volumes of shares, the NSE 20 share indices and the 91-·day treasury bill rates for the years 2001 to 2005_ Chapter one introduced portfolio analysis in the context of a fund such as pension schemes and outlined the historical development of the Nairobi Stock Exchange. The study then described the research problem as the challenge of selecting and managing an optimal portfolio in a vibrant stock market such as the Nairobi Stock Exchange. The study objectives included the selection of an optimal portfolio based on the most actively traded stocks at the segmented NSE, a comparative evaluation of the MPT and CAPM portfolio analysis models as well as recommendations based on the study findings. Chapter two did a theoretical review of portfolio analysis and management, fundamental analysis, technical analysis, market segmentation theory, risk, the relationship between risk and market segmentation, and the efficient market hypothesis. An empirical review of past global studies on the standard finance theories and studies on portfolio analysis and finance theories based on the Nairobi Stock Exchange was done. The portfolio analysis models of the Modern Portfolio Theory and the. Capital Asset Pricing Model were described in chapter three. In each model, a historical background is given, the assumptions explained, the model is developed with their formulae and graphs and their past criticisms and limitations discussed. The study methodology described in chapter four included the research design which was an event study descriptive case/study on the Nairobi Stock Exchange, the target population, the sample frame and sample design mainly comprised of the most actively traded stocks at the NSE, data collection procedures as well as data analysis techniques which involved the use of MS EXCEL spreadsheet and the statistical SPSS software in the comparative evaluation of returns and risks from the three techniques of the Single Market Model, the Modern Portfolio Theory and the Capital Asset Pricing Model. The study findings were then outlined with significant variations in the returns from the three techniques. The overall average returns for the same portfolio of eight selected stocks yielded returns of 13, 49 and 5 percent from the SMM, MPT and CAPM portfolio analysis models respectively. In order to establish the statistical significance of the study findings on the returns, a correlation analysis, a regression analysis, the student t-test and a chi-square analysis all indicating that the MPT and CAPM portfolio analysis techniques were not accurate in predicting the historically observed returns calculated using the Single Market Model. However, the CAPM was better than the MPT model in accuracy because it incorporated more parameters such as standard deviation, beta, covariance, the NSE 20-share index and the 91-day tax free rate in its calculations making it more realistic compared with MPT which relied on weighted average returns. The study concluded in chapter five that the MPT model exaggerated positive returns because of the weighting factors of the traded volumes. The fact that both MPT and CAPM models ignored dividends reduced their accuracy and pragmatism compared with the SMM model. The study noted that CAPM included more parameters such as the standard deviation, beta, covariance, the NSE 20-share index and the 91-day treasury bill rate in its calculations making it more realistic compared with MPT which relied on weighted average returns. On the MPT model, the study recommended that the weighting factors in the form of traded volumes of stocks can be adjusted so that they do not magnify positive changes in the prices of shares. A trend analysis such as decomposition and cyclical variations could be incorporated so that the weighting factors are more accurate. The study made recommendations on how to improve both the MPT and CAPM models. For example, the weighted mean concept of the MPT model could be improved by introducing geometric means instead of arithmetic mean used at the moment. The study recommended that the MPT models adjusts its recommendations so that they are more realistic of the capital markets in the real world. Although, removing some of the assumptions would complicate the MPT calculations, the study recommended that this was justified given the study findings which revealed that the MPT returns were not accurate in estimating portfolio returns. On the CAPM model, the study recommended that the use of the 91-one day treasury bill rate as the risk free rate used in the CAPM model could further be improved through globalization into an international standard such as the European Union rate, the United States of America treasury bill rate or even a rate from the International Monetary Fund. This will have the impact of globalizing the research findings and anchor the results on a larger and stable economic basis. The CAPM model assumes that the variance of returns is an adequate measurement of risk. This might be justified under the assumption of normally distributed returns, but for general return distributions other risk measures (like coherent risk measures) will likely reflect the investors' preferences more adequately. Indeed risk in financial investments is not variance in itself, rather it is the probability of losing: it is asymmetric in nature. The model assumes that all investors have access to the same information and agree about the risk and expected return of all assets. The study therefore recommended that a more concise risk measurement which include fundamentals such as Earnings Per Share, industry issues and the macro-economic outlook be adopted under CAPM calculations.