Examining the superiority of the Sharpe single-index model of portfolio selection: A study of the Indian mid-cap sector

Abstract

The purpose of the article was to examine the superiority and efficacy of Sharpe’s single-index model of portfolio optimisation. The study has attempted to build an optimal portfolio of Indian mid-cap companies using William Sharpe’s single-index model. The methodology is also known as the Market model. A portfolio was selected from the Nifty mid-cap 100 index of the NSE. MS-Excel 365 has been used for the analysis. The optimal portfolio returns during the fixed period of analysis were compared with the returns of the benchmark market portfolio. The return of the optimal portfolio using Sharpe’s model was found to be considerably higher than the benchmark market portfolio and the risk of the same was found to be much lower. Hence it could be established that in the five years of the study period, the optimal portfolio outperformed the benchmark market portfolio—the Nifty mid-cap 100 index. The selected optimal portfolio was also found to be well diversified comprising 11 securities and eight sectors. The limitation of this model is that it was based on historical data and hence, in case of extreme market conditions, the optimal portfolio could fail to give superior returns. Sharpe’s model resolves most of the technical difficulties of the earlier portfolio models and can very well be used by individual investors as well as portfolio managers worldwide to build optimal portfolios. The study has focussed on the mid-cap sector which is riskier than the large-cap sector. This is one of the first studies which has shown the efficacy of the single-index model for mid-cap companies in India.