Date of Graduation

Spring 2016

Document Type

Honors Research Project

Degree Name

Bachelor of Science

Major

Statistics

Research Sponsor

Nao Mimoto

First Reader

Richard Einsporn

Second Reader

Marcus V. Braga Alves

Abstract

Our goal is to investigate strategies to deal with the risks associated with holding asset in the stock market. We first deal with risk of holding a specific stock, by the use of diversification. Later, we’ll attempt to deal with the market risk, which is the risk of entire market going up and down. Data used in this project comes from daily adjusted closing price of stocks listed in the S&P500 index ranging from January 3rd, 2000 to December 31st, 2015 and the data is processed using statistical software R.

Sections 2 through 4 of this paper demonstrate diversification and how to lower stock specific risk. Section 2 shows a case with two stocks in a portfolio. Moreover, the ideal portion of your budget allocated to each stock in the portfolio will be discussed.

Section 3 scales up the discussion to twenty benchmark stocks in a portfolio. Creating thousands of potential portfolios was more difficult to compute, but it was necessary for Section 4. This part is the evaluation of how much money the portfolios create compared to just using the overall S&P500.

Section 5 discusses calculating a stock’s beta, alpha, from Sharpe’s single index model and correlation with the S&P500, then calculate the same measures for the portfolio overall. By using those measures, we’ll attempt to make our portfolio neutral to the market. That is, on average, the portfolio’s value will change independent of the market in crisis situations. This part will deal with the market risk component and mix in with our diversification from above to also deal with stock specific risk.

Comments

Dr. Mimoto showed me a lot, and discovering how to effectively allocate random weights that add to 1 was quite an interesting piece to go with the stock diversification research.

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