The Application of ARIMA and Mean-variance Models on Financial Market

Abstract

This study centers on forecasting return and constructing proper portfolios with 5 typical assets rarely focused on the Chinese A-share market. This paper applies the fittest ARIMA models for each of the selected stocks to predict their trend of returns in the next 20 days. Besides, we create the efficient frontier by Monte Carlo simulation under Markowitz’s Mean-Variance framework to focus on two portfolios, i.e., the maximum Sharpe ratio portfolio and the minimum volatility portfolio. The empirical results of the ARIMA model indicate a rational prediction of return for assets in the A-share market. The maximum Sharpe ratio portfolio and the minimum volatility portfolio show that stock of Foshan Haitian Flavouring and Food Company Ltd. and stock of China Merchants Bank Co., Ltd. account for the largest proportion in the two portfolios. Further empirical results show that returns for two portfolios are higher than the market index return, which illuminates the two portfolios outperform the market index. The results in this paper will surely benefit related investors in the financial market.