Optimal portfolio selection using rule-based fuzzy expert system

Dissertation for Master degree (M.A)

Trend: Finance

Dissertation abstract (including summary, objectives, implementation methods and obtained results):

The purpose of this research is to build suitable portfolios by considering the level of risk tolerance of investors and their preferences in a flexible, practical and realistic way. For this purpose, a rule-based fuzzy expert system is built to support investment managers in their mid-term investment decisions. The performance of the proposed expert system has been investigated by the data of 106 stocks traded in the Tehran Stock Exchange between 2014 and 2016. The performance of the proposed expert system has been analyzed in terms of risk tolerance and the length of the investment period, compared to the market average. The results show that the proposed expert system performs better than the market in most cases. Also, according to our expectations, the performance of this expert system is better for the risk-averse investor in the medium term.

Statement of the problem

One of the ways to invest and form a portfolio of assets is investing in the stock exchange. In developed countries, most of the investments are made through financial markets (stock exchanges). Choosing and choosing the stocks of the companies present in the stock exchange and forming the optimal stock portfolio depends on several factors that complicate decision making for analysts and experts. Many researches and studies have been done in the field of determining the priority of stock selection criteria and forming the optimal portfolio according to different criteria and using modern models in interaction with each other. However, quantitative models simultaneously consider fundamental and technical approaches for portfolio construction. The main issue of this research is stock evaluation and portfolio construction using an expert system that considers both approaches. Now the question is whether it is possible to use this system and the selected inputs to choose the portfolio that is the most profitable stock portfolio, and whether this decision will be made more quickly and accurately than the classic models of portfolio selection? 1-2 Research Objectives The main objective of this study is to build the optimal stock portfolio using a rule-based fuzzy expert system. Other goals include: examining the performance of the model in portfolio selection, interaction between decision makers and the high-level system, supporting portfolio managers in investment decisions.

1-3 The importance of the research topic and the motivation for choosing it

A) Optimal investment, in addition to increasing the wealth of shareholders, also causes the economic growth of any country in the macro view.      

B) The use of new and more accurate models can increase the return on investment and also lead to optimal capital allocation.

C) Entering the capital market and using new tools in order to obtain more efficiency is a step towards making the market more efficient.

Second hypothesis) The proposed expert system has better performance for risk-averse investors.

Third hypothesis) The proposed expert system has better performance in the medium term.

1-5 Research model

Figure 1-1 Work process

1-6 Operational definitions of variables and keywords

Expert system: a computer system including a body of knowledge that It is well organized, it imitates the problem solving skills of experts in a limited skill domain (Bahrammirzaee, 2010). In some parts, the concept of expert system refers only to basic knowledge systems (Rada, 2008).

A rule-based expert system: a computer program that is able to use knowledge-based information through sets of inferential procedures to solve problems that are difficult enough to require significant human skill to solve them (Harmon P, 1985).

Fundamental analysis: fundamental analysis (or fundamental) is one of the methods of capital market analysis and price prediction. The fundamental analysis of a company includes the analysis of financial reports and financial health of the company, management and competitive advantages, competitors and relevant markets.

Technical analysis: It is a method of predicting prices in the market by studying the past state of the market. In this analysis, it is possible to predict the price situation in the future by examining the changes and fluctuations of prices and volume of transactions and supply and demand. This method of analysis is widely used in foreign markets, stock market, gold market and other precious metals. The most important principle of technical analysis is that the price reflects everything about a share (Latfi, Darwish, 2015, 1).

Technical index: A technical indicator is a tool through which you can analyze price behavior (same source, 2015, 15).

1-7 research method

It is a survey type description. Library method is used to collect scientific literature and background check. Also, the current research is carried out within the framework of the basics of modeling and the use of information systems in the field of financial management.

1-8 scope of research

a) spatial domain: all companies admitted to the stock exchange

b) temporal domain: between the years 1384 and 1389

c) thematic domain: in the field of financial management and capital market

1-9 Population and sample size

The statistical population of this research includes companies active in the Tehran Stock Exchange between 1384 and 1389.

From the statistical population and based on the following criteria, 106 companies were selected as a sample:

The companies were admitted to the stock market by the end of March 1383 and were delisted from the stock market by 1389.

Fiscal year of all companies must be the end of March.

The company has not changed its fiscal year during this period.

The trading symbol of the companies has not been stopped for more than three months.

The financial information they need is available. All listed companies have different fiscal years.

Introduction

The portfolio management process is a coherent set of steps that make the right portfolio to achieve investment goals and maintain it. It will be very useful and valuable to build a portfolio that is in accordance with the level of risk tolerance of the investor and his personal preferences, and in addition, it is a collection of assets that have favorable risk and return characteristics. Portfolio management is a multi-dimensional problem, and a multi-criteria decision-making approach provides methodological foundations for solving the multi-criteria nature of the problem. Using technical and fundamental analysis simultaneously, in addition to investors' preferences, can be very appropriate. In addition, due to the fact that investors have relative information about the market and have to face a high level of uncertainty, also the interaction between technical and fundamental criteria is not certain, the problem is complicated and uncertain and is not structured. Therefore, the use of artificial intelligence techniques is very beneficial. Among these techniques, the rule-based expert system is a very suitable framework for problem solving. Financial planning is what most people do. Before people start investing, each person should prepare a general financial plan. Such a plan should include making a decision regarding the transaction. In addition, the method of ownership, the life span of the asset and its profitability should also be considered. Finally, this plan should include the minimum amount of necessary savings. Investors seek to manage and enhance their wealth and assets by investing in an optimal mix of financial assets. The concept of optimal combination is important, because people's wealth, which is kept in the form of different assets, should be evaluated and managed as a unit. Wealth should be managed and evaluated in the form of a portfolio. A portfolio includes an investor's investment collection.

2-1-2 Why do we invest?

Investment is made to make money. Although everyone agrees with this statement, we need to be more precise about it. We invest to improve our current and future well-being.