COINTEGRATION AND ITS SPECIFIC APPLICATIONS IN PORTFOLIO MANAGEMENT

Cointegration becomes the prevalent statistical tool in financial economics. In passive stock portfolio management enables the replication of stock index and construction of portfolio with better characteristics than index itself. It is a powerful technique for investigating long term dependence in multivariate time series. In our paper we construct cointegration based portfolios that differ in number of selected stocks, interval of reselection, calibration period, and transaction costs. We considered an allocation into portfolio consisting of Dow Jones Industrial Average components and thereafter we compare long term return and risk profile of portfolios focus on cointegration selection process and index DJIA. The cointegration technique enabled us to use long calibration period and provided that portfolio weights do not change too much over time and outperform the index DIM in post-sample performance measurement.