Enhancing portfolio optimization: A comparative analysis of the mean-variance Markowitz model and risk-parity contribution strategies

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Abstract

Financial markets are still exposed to various crises that increase stock price fluctuations and make predictions extremely difficult (Nguyen et al., 2024). Although there are many diversification methods for building investment portfolios, there has been no agreement on the best of them. This research aims to identify the most effective strategy for constructing an optimal investment portfolio by comparing the mean-variance (MV) model and risk-parity (RP) contribution strategies during the uncertain market period 2018–2022. The study used a quantitative and an optimization method following Ofikwu (2019) based on three critical criteria: 1) low asset correlation, 2) the highest Sharpe ratio, and 3) a mixed strategy for a sample of firms listed in the Amman Stock Exchange (ASE). The results show that the MV model has the highest Sharpe ratio (15.06 percent and 11.84 percent) when applied to the Sharpe and mixed strategies respectively. In comparison, using the low correlation strategy the RP model gains the highest Sharpe ratio (14.92 percent). During COVID-19, all portfolios had a higher positive return and lower total risk than the market portfolio. Both models are valid to be used during uncertain conditions. It highlights the effectiveness of strategies in navigating challenging market conditions and offers practical guidance for investors in uncertain times for asset allocation.

Keywords: Portfolio Optimization, Risk-Parity Model, Markowitz Model, Sharpe Ratio, COVID-19 Pandemic, Amman Stock Exchange

Authors’ individual contribution: Conceptualization — R.H.H. and F.K.S.; Methodology — R.H.H. and F; Software — R.H.H. and F.K.S.; Validation — R.H.H. and F.K.S.; Formal Analysis — R.H.H. and F.K.S.; Investigation — R.H.H.; Resources — R.H.H. and F.K.S.; Data Curation — R.H.H.; Writing — R.H.H. and F.K.S.; Supervision — R.H.H. and F.K.S.; Project Administration — R.H.H. and F.K.S.; Funding Acquisition — R.H.H. and F.K.S.

Declaration of conflicting interests: The Authors declare that there is no conflict of interest.

JEL Classification: C61, D53, F65, G11

Received: 25.12.2023
Accepted: 05.07.2024
Published online: 09.07.2024

How to cite this paper: AlHalaseh, R. H., & Al Shawawreh, F. K. (2024). Enhancing portfolio optimization: A comparative analysis of the mean-variance Markowitz model and risk-parity contribution strategies. Corporate & Business Strategy Review, 5(3), 124–136. https://doi.org/10.22495/cbsrv5i3art12