Determining the optimal trading strategy of a second tier fund manager under different covariance structures
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Date
June, 2016
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Abstract
The 2nd-tier fund managers have limited investment capital, making it impossible
to invest in all securities on the stock market. However investing in fewer stocks
may not present the needed financial base that could withstand the possible
financial shocks and guarantee high returns. On the other hand, actuaries can
employ actuarial tools such as covariance structure to forecast the prospects of
a selected stocks which could complement each other to reduce the probable
risk and improve investment output. Fund managers are therefore required to
make an informed investment decisions adopting reliable actuarial tools that
could minimize the risk that can be associated with investing in fewer stocks.
The decision they make on their investments affect returns, and that of their
clientèle eventually. The study looked at three different covariance structures:
Toeplitz, Autoregressive(1) and Unstructured and the amount to optimally invest
in each security under these structures. Correlated and uncorrelated stocks under
the different covariance structures on simulation study were studied. Monthly
data was taken from companies that deal in AAPL, TNET and BAX from 1st
January, 2008 to 31st December, 2012. Kolmogorov - Smirnov and Anderson
Darling tests were used to check the distributions of the market data. After
a hypothesis testing,the observation was that AAPL, BAX and TNET were
from the Normal, Weibull and Weibull distributions respectively with a negative
correlation between BAX and TNET. Inferring from the results obtained in this
study, investing more than half of the investment capital in the TNET security
was considered optimal. In conclusion, this study has demonstrated that fund
managers can rake in high returns if more than half of the amount available for
investment was put in the TNET security. Additionally, the Toeplitz covariance
structure proved efficient in predicting the suitable stocks to invest the 2 tier
fund.
Description
A thesis submitted to the Department of Mathematics, Kwame Nkrumah University of Science and Technology in partial fufillment of the requirement for the degree of M.Phil Actuarial Science,