The Efficiency between Markowitz Model and Single Index Model

Abstract

It is important to investigate the different impact factors on the establishment of investment portfolio. In order to maximize the profit of a portfolio, this research selects six stocks: Adobe (ADBE), International Business Machines Corp (IBM), Bank of America Corporation (BAC), Citigroup (C), Southwest Airlines Co (LUV) and Alaska Air Group Inc. (ALK) as an empirical case to conduct investment decision. This research compares different results of two models (Markowitz model and Index Model) by analyzing the data of the portfolio such as minimum risk portfolio and maximum Sharpe Ratio portfolio. This research finds that the Markowitz Model is more appropriate to the portfolio establishment, which is presented by its sharper efficient frontier. Under all the conditions the study considered, the Markowitz Model always gets more returns than the Index Model when the risk increases by the same amount. Therefore, this research concludes that the Markowitz Model is more suitable for this portfolio. By analyzing the portfolio in two models, the study has found a better model for this portfolio, thus make more rational investments.

Portfolio Optimization: Application and Comparison of Markowitz Model and Single Index Model on LQ45 Stocks in Indonesia Stock Exchange

“…The research landscape surrounding optimal portfolio formation spans various models and methodologies, each offering unique insights into investment decision-making. Studies such as Cai & Long (2022) and Ni (2022) delve into comparing the effectiveness of the Markowitz model and the Index model, highlighting nuances in portfolio construction. Cai & Long (2022) emphasize the sharper efficient frontier of the Markowitz model, indicating its suitability for maximizing returns, while Ni suggests that the Index model requires less computational effort, albeit with slightly better portfolio outcomes.…”

“…Studies such as Cai & Long (2022) and Ni (2022) delve into comparing the effectiveness of the Markowitz model and the Index model, highlighting nuances in portfolio construction. Cai & Long (2022) emphasize the sharper efficient frontier of the Markowitz model, indicating its suitability for maximizing returns, while Ni suggests that the Index model requires less computational effort, albeit with slightly better portfolio outcomes. Wang (2022) extends this exploration by investigating the impact of external factors like COVID-19 on portfolio performance, revealing differential outcomes under various constraints for both models.…”