Optimum Allocation of Weights to Assets in a Portfolio: The Case of Nominal Annualisation Versus Effective Annualisation of Returns

Abstract

Since the introduction of modern portfolio theory by Roy (1952), Markowitz (1952) and Sharpe (1964) about half a century ago, the allocation of investment weights among various assets in a portfolio is one of the most important areas of research in finance. However, we are not aware of any study that has compared the allocation problem under nominally annualised versus effectively annualised returns. In this paper, we empirically examine the effect of effective annualisation on the variance and skewness of the rates of return probability distribution and the allocation of weights to assets in the portfolio. Our empirical findings conclude that the method of annualisation drastically affects the variance and skewness as well as the allocation of weights to the assets in the portfolio.

Keywords: Portfolio Allocation, Annualization, Returns, Weights, Skewness

JEL Classification: G12