The procedure used to calculate the optimal portfolio when short sales are allowed is, more or less similar to the procedure adopted for no short sales, except the cut-off point concept. At first, the stocks have to be ranked by excess return to beta.
Optimum Portfolio With Short Sales
The procedure used to calculate the optimal portfolio when short
sales are allowed is, more or less similar to the procedure adopted for no
short sales, except the cut-off point concept. At first, the stocks have to be
ranked by excess return to beta.
Here, all the stocks are added to the portfolio They are either held
long or short. All the stocks affect the cut-off point. The Z value has to be
calculated for each stock. If the Z value is positive, the stock will be held
long and if negative, it will be sold short. Stocks which are having excess
return to beta above C* are held long as in the case of the portfolio without
short sales. Stocks with an excess return to beta below C* aresold short. In
the case of previous example C* = C = 7.9, if short sales are permitted, then
The seventh stock will be sold short.
The proportion can be had using: