Overcoming the uncertainties of an economic downturn using a universal portfolio in investment

Abstract

In (Cover and Ordentlich, 1996) a parametric class of universal portfolios generated by the Dirichlet ) ..., , ( 1 m a a probability distribution is introduced and the study is focused on the universal portfolios generated by the Dirichlet (1, …, 1) and Dirchlet (1/2, …,1/2) distributions. In an earlier study by Cover (1991) the Dirichlet (1, …, 1) or the uniform portfolio was shown to perform well over a 22-year period on stocks listed on the New York Stock Exchange. In this study, two sets of stock price-relatives of 600 and 430 trading days were selected from the Kuala Lumpur Stock Exchange. Each set consists of stock pricerelatives of three Malaysian companies covering the economic downturn period of October 2008 until March 2009. The Dirichlet (1, …, 1) and Dirchlet (1/2, …,1/2) universal portfolios were shown to perform badly on the two data sets. We show that by varying the values of the parametric vectors ) , , ( 3 2 1 a a a , it is possible to find certain parametric vectors ) , , ( 3 2 1 a a a that can perform well on the stocks, implying that it is possible to ride out the storm in an economic downturn by choosing an appropriate universal portfolio. The Dirichlet (1, …, 1) and Dirichlet (1/2, …,1/2) universal portfolios may not perform well on all stocks and hence it is important to identify the appropriate parameter ) ..., , ( 1 m a a that can bring us higher returns in stock investment.