Modern Portfolio Theory And Its Application To The Chinese Stock Market

In the framework of the Markowitz mean-variance analysis, the modern portfolio theory is applied to the empirical study of the Chinese stock market with emphasis of risk control and risk diversification. In the analysis of the factor model, the total risk ofthe stock return is divided into system risk and individual risk and the R2 measure isused as an indicator of the system risk in the stock return risk. Our statistical result shows that the system risk of the stock return is reduced significantly, comparing with the earlier period of the Chinese stock market. The potential of the risk diversification of a stock portfolio is greatly enhanced. Furthermore, we examine the efficient frontier in the Shanghai, Shenzhen and the Closed-end fund market. The efficient frontier in Shenzhen is superior to the Shanghai efficient frontier characterized with higher return and higher volatility. With respect to the closed-end fund market and the stock market, we find that the efficient frontier of the fund market is superior to the stock market in the low yield area; this has great significance to the investment of the Chinese insurer, which is highly regulated in their investment activity because of the high volatility of the Chinese stock market. Finally, with Tobin's "Separation Theorem", we introduce the transaction cost into the efficient frontier and the effective efficient frontier is obtained. And a quadratic utility function is applied to demonstrate that maintaining a suitable level of transaction cost in the current Chinese stock market is important to the equilibrium of the Chinese stock market and the risk control of the individual asset.