Investigating stochastic portfolio theory with applications to the South African equity market

Abstract

Stochastic Portfolio Theory (SPT) as a methodology aims to move away from the e cient market hypothesis which was developed mainly as a way of explaining the relationship between risk and returns. SPT attempts to explain stock market behaviour using only the assumption of a logarithmic model of stocks, which is widely used in derivative pricing and hedging. This provides a potential tool for portfolio management and an alternative to the commonly used mean-variance approach of Markowitz. The aim of this dissertation is to provide an overview of the foundations of Stochastic Portfolio Theory, the consequences for portfolio construction and behaviour and apply these concepts to the South African Equity Market.