Mourad Mroua

The Impact of Option Strategies in Financial Portfolios Performance: Mean-Variance and Stochastic Dominance Approaches

This study employs the mean-variance (MV) criterion, Capital Asset Pricing Model (CAPM) statistics and stochastic dominance (SD) analysis to investigate the performance of option strategies, including writing out-of-the-money (OTM) covered call and buying in-the-money (ITM) protective put, with that of the pure-stock investment by analysing the French data in the entire 1999 year. Our results from MV criterion show that none of these three strategies dominate one another but our CAPM statistics show that in general buying ITM protective-put strategy obtains the highest performance, followed by the writing OTM covered-call strategy while the naked stock obtains the smallest values. This confirms the superiority of ITM protective-put strategy, followed by OTM covered-call strategy by using the Beta coefficient, Sharpe ratio, Treynor and Jensen indices. As the return distributions of these strategies are non-normal, the MV criterion and the CAPM statistics may not be appropriate to assess the relative performance measurement of the portfolios. We further investigate the performance by employing SD approach. Our SD findings reveal that most of the buying covered-call and writing protective - put strategies are superior to their corresponding pure-stock strategy, as in general the former stochastically dominates the latter in the sense of first order SD. This infers that there may exist an anomaly of the existence of an arbitrage opportunity in option trading that all types of non-satiated investors will increase their wealth and utility by switching from the pure unhedged stock strategy to their corresponding buying protective - put or writing covered-call strategies. In addition, we find the dominance relationship between the two hedged positions is not as clear as the comparison with their unhedged positions, but on average more buying ITM protective put outperforms writing OTM covered call in the sense of the first-order SD. In short, our results confirm that option introduction improve significantly the performance of unhedged portfolios, especially buying ITM protective put.

Should Americans invest internationally? mean–variance portfolios optimization and stochastic dominance approaches

Using both mean–variance portfolio optimization (MVPO) and stochastic dominance (SD) approaches, this paper investigates whether international diversification and home bias inertia are substitutes or complements for Americans. More specifically, we compare daily closing prices of 30 US stocks and the stock indices from American, Latin American, and Asian financial markets, including both emerging and major markets. Results from the MVPO show that a domestic diversification strategy performs better for any risk level up to 0.5%, whereas international diversification performs better for any risk level higher than 0.5%. Some results from the SD test support international diversification, some promote home bias, and still others conclude that there is no difference between investing domestically and internationally. However, our findings show that one could not find any single internationally diversified portfolio that dominates all domestically diversified portfolios and, similarly, one could not find any single domestically diversified portfolio that dominates all internationally diversified portfolios. At last, our SD findings also recommends that the US investors have a “home bias” if they prefer less risk and to be “internationally diversified” if they prefer higher risk.

Further evidence on international Islamic and conventional portfolios diversification under regime switching

ABSTRACT This article investigates the comparative performance of International Islamic and conventional portfolio diversification across different financial market regimes and provides an optimal choice from an American investor’s viewpoint during the period 2002–2014. Using a bootstrap-based stochastic dominance (SD) test and monthly MSCI prices of Islamic stock market indices and their conventional counterparts in 38 countries from North and Latin America, Europe and Asia-Pacific regions, we find that SD relationships between Islamic and conventional optimal-diversified portfolios change systematically according to investment region and market regime. Essentially, for all regimes, US investors are indifferent between Islamic diversification and its conventional counterpart, which implies that arbitrage diversification opportunities are rare and short lived in all regions. However, across all regions, especially in a crisis regime, Islamic portfolio diversification can be a good substitute for conventional diversification. Islamic portfolio diversification in North and Latin America, Europe and Global regions is an optimal choice for the risk-averse American investors. Finally, results imply that portfolio diversification among Islamic market indices can be a good hedge, offering investors superior investment alternatives during any financial meltdown or economic slowdown due to the conservative nature of Sharia-compliant investments.

Portfolio revision and optimal diversification strategy choices

Purpose - – Since equity markets have a dynamic nature, the purpose of this paper is to investigate the performance of a revision procedure for domestic and international portfolios, and provides an empirical selection strategy for optimal diversification from an American investors point of view. This paper considers the impact of estimation errors on the optimization processes in financial portfolios. Design/methodology/approach - – This paper introduces the concept of portfolio resampling using Monte Carlo method. Statistical inferences methodology is applied to construct the sample acceptance regions and confidence regions for the resampled portfolios needing revision. Tracking error variance minimization (TEVM) problem is used to define the tracking error efficient frontiers (TEEF) referring to Roll (1992). This paper employs a computation method of the periodical after revision return performance level of the dynamic diversification strategies considering the transaction cost. Findings - – The main finding is that the global portfolio diversification benefits exist for the domestic investors, in both the mean-variance and tracking error analysis. Through TEEF, the dynamic analysis indicates that domestic dynamic diversification outperforms international major and emerging diversification strategies. Portfolio revision appears to be of no systematic benefit. Depending on the revision of the weights of the assets in the portfolio and the transaction costs, the revision policy can negatively affect the performance of an investment strategy. Considering the transaction costs of portfolios revision, the results of the return performance computation suggest the dominance of the global and the international emerging markets diversification over all other strategies. Finally, an assessment between the return and the cost of the portfolios revision strategy is necessary. Originality/value - – The innovation of this paper is to introduce a new concept of the dynamic portfolio management by considering the transaction costs. This paper investigates the performance of a revision procedure for domestic and international portfolios and provides an empirical selection strategy for optimal diversification. The originality of the idea consists on the application of a new statistical inferences methodology to define portfolios needing revision and the use of the TEVM algorithm to define the tracking error dynamic efficient frontiers.

Optimal diversification, stochastic dominance, and sampling error

Purpose - The purpose of this paper is to contribute to the literature in three ways: first, the authors investigate the impact of the sampling errors on optimal portfolio weights and on financial investment decision. Second, the authors advance a comparative analysis between various domestic and international diversification strategies to define a stochastic optimal choice. Third, the authors propose a new methodology combining the re-sampling method, stochastic optimization algorithm, and nonparametric stochastic dominance (SD) approach to analyze a stochastic optimal portfolio choice for risk-averse American investors who care about benefits of domestic diversification relative to international diversification. The authors propose a new portfolio optimization model involving SD constraints on the portfolio return rate. The authors define a portfolio with return dominating the benchmark portfolio return in the second-order stochastic dominance (SSD) and having maximum expected return. The authors combine re-sampling procedure and stochastic optimization to establish more flexibility in the investment decision rule. Design/methodology/approach - The authors apply the re-sampling procedure to consider the sampling error in the optimization process. The authors try to resolve the problem of the stochastic optimal investment strategy choice using the nonparametric SD test by Linton Findings - First, the authors find that reducing sampling error increases the dominance relationships between different portfolios, which, in turn, alters portfolio investment decisions. Though international diversification is preferred in some cases, the study’s results show that for risk-averse US investors, in general, there is no difference between the diversification strategies; this implies that there is no increase in the expected utility of international diversification for the period before and after the 2007-2008 financial crisis. Nevertheless, the authors find that stochastic diversification in domestic, global, and Europe, Australasia, and Far East markets delivers better risk returns for the US risk averters during the crisis period. Originality/value - The originality of the idea in this paper is to introduce a new methodology combining the concept of portfolio re-sampling, stochastic portfolio optimization with SSD constraints, and the nonparametric SD test by Linton

Portfolios Resampling and International Diversification: A Non-Parametric Stochastic Dominance Approach

The aim of this paper is to consider instability and ambiguity problems on portfolio selection. We examine the impact of estimation errors on financial portfolios optimization processes. We investigate the controversy problem of international and domestic optimal diversification strategies choices using a non parametric stochastic dominance approach (NPSDA) based on Monte Carlo (MC) and Bootstrap p-values from an American point of view. Based on a data set consisting of daily closing prices of U.S. stocks and index and Asian and Latin American stock market indices for the period from August 03, 1993 to August 31, 2007, estimation errors visualisation results show that small changes in input parameters imply large changes in the optimized portfolio composition and a considerably modification of mean-variance efficient frontiers shape. Though mean-variance optimization could not be used to draw any preference between international and domestic diversification, empirical findings reveal the utility of the SD approach to define an optimal strategy. Further, results show that there exists substantial evidence of international global diversification benefits for domestic investors. More precisely, for risk levels higher than 30 percent, risk-adverse American investor having an increasing utility function prefers global international to domestic resampled diversification strategy. Besides, we find that domestic resampled diversification strategy beats all international major and emerging markets diversification strategies. For risk levels lower than 30 percent and 23.98, respectively, U.S. investor having a high risk-aversion coefficient prefers domestic to international major and emerging markets diversification and invests 77 percent and 82 percent, respectively, of his wealth’ locally. SD analysis suggests that global international diversification dominates entirely major and emerging markets diversification strategies for a U.S. risk-adverse investor having an increasing utility function. Finally, the findings of the SD tests reveal that risk-adverse U.S. investor having an increasing utility function prefers to diversify 45 percent of his wealth in major markets rather than in emerging markets.

Does International Diversification Substitute for Home Bias

Using both mean-variance portfolio optimization (MVPO) and stochastic dominance (SD) approaches, this paper investigates whether international diversification and home bias inertia are substitutes or complements. More specifically, we compare daily closing prices of 30 US stocks and the stock indices from American, Latin American, and Asian financial markets, including both emerging and major markets. Results from the MVPO show that a domestic diversification strategy performs better for any risk level up to 0.5%, whereas international diversification performs better for any risk level higher than 0.5%. Some results from the SD test support international diversification, some promote home bias, and still others conclude that there is no difference between investing domestically and internationally. However, our findings show that one could not find any single internationally diversified portfolio that dominates all domestically diversified portfolios and, similarly, one could not find any single domestically diversified portfolio that dominates all internationally diversified portfolios. Our SD findings also recommends that investors have a “home bias” if they prefer less risk and to be “internationally diversified” if they prefer higher risk.