Undiversifiable market risk is a crucial factor that a risk-averse investor must consider while making any investment decision. We focus on dynamic market risk using time-varying beta for 10 different sectoral indices from the Indian stock market, analyse its movement over volatility regimes, and explore its relation with market stress. The sectors that are most resilient towards market risk are chosen to construct the best portfolio for a risk-averse investor. Our findings suggest that mere consideration of market risk and not taking its variability into account may leave a large chunk of risk unattended for a risk-averse investor.
This paper focuses on the undiversifiable market risk of Indian sectoral stock indices. While such market risks are time-varying, they pass through different volatility regimes and even escalate when the market plunges into stress and crises. We isolate the most resilient sectors to construct a risk-averse investor’s portfolio. We use daily data on 10 sectoral indices for the period 2006−2021. Sectoral time-varying betas (TVB) are estimated using the multivariate GARCH model. A three-regime Markov switching model explores their movements, and a stress index (coefficients of market stress) checks whether such risks escalate under crises. Subsequently, the most resilient sectors are identified to construct the minimum-variance portfolio. The resilience of such a portfolio during major crises such as the financial meltdown of 2007−2008 and the recent pandemic has been established by time-varying value-at-risk method. Our findings suggest that mere consideration of market risk and ignoring its variability underestimates the risks of investment. With regime-switching market risks that escalate under stress, sectors are to be ranked judiciously. Aggressive sectors may be included in minimum-variance portfolios, while investing in defensive assets may not always help with hedging. Regime-switching behaviour of dynamic market risks that escalate under market stresses has hardly been incorporated in the literature on the construction of resilient portfolios. The results have significant implications for investors. The mere consideration of market risk and dealing with it in the traditional way is not sufficient. Market risks are undiversifiable but ignoring them makes them unmanageable.
