Portfolio Selection Based On CAPM And Momentum / Inverse Strategy

Rational investors make investment decision based on some strategies and two general strategies are capital asset price model(CAPM) and momentum/contrarian strategy. The hypothesis of CAPM is that market is efficient, and the corresponding optimal portfolio is the market portfolio; the hypothesis of momentum/contrarian portfolio is that market is not efficient, and the corresponding optimal portfolio is an arbitrage portfolio. Investors who know both strategies well won’t adopt single strategy.The problem this paper is trying to solve is the portfolio choices of hypothetical mean-variance investors who allocate wealth between the market portfolio and a momentum/contrarian portfolio using a Bayesian methodology developed by Pastor(2000). These investors have different prior beliefs about the ability of CAPM to price the momentum portfolio. The thesis also finds there is a momentum / contrarian effect in China stock market and which parameters make up optimal momentum/contrarian strategy.Firstly, we construct the optimal winner portfolio, loser portfolio, momentum portfolio and contrarian portfolio, the best of which behaves as the arbitrage portfolio in the final portfolio. Secondly, under the framework of Bayes, this paper introduce prior believe parameters into the implications of the capital asset pricing model. Thirdly, the thesis turns to sample(simulation) from the joint predictive distribution with Monte Carlo integration, repeats the procedure a large number of times and collects excess return of market portfolio and arbitrage portfolio. Finally, the paper calculates the joint predictive mean, covariance and optimal portfolio weights. And then this paper repeats the above procedure with different prior parameters and keep an eye on changes of final weight.Not surprisingly, investors with less prior confidence in the CAPM eventually allocate more to the arbitrage portfolio. However, investors who are totally skeptical of CAPM also invest in market portfolio. In addition, traditional winner-momentum and contrarian strategies are effective in China stock market, in which loser-contrarian performs best.The conclusion of this paper corresponds to the inference of effectiveness market theory. This paper combines the contrarian portfolio with market portfolio, which extends the research of multi-strategy portfolio.