Optimal Portfolio Construction Under Market Inefficiency: The Role of Firm Size and Financial Leverage in Iraq

This research investigates the influence of the size of a company and of the company’s debt (leverage) on how investment portfolios perform on the Iraqi Stock Exchange. To accomplish this, investment portfolios were constructed using size and leverage classifiable monthly data over time. These were analyzed using a number of different metrics to determine portfolio performance such as monthly returns, portfolio beta, the Sharpe and Treynor ratios, Jensen’s alpha, and the information ratio. A quantitative approach using the Generalized Estimation Equations (GEE) model was used for the analysis to determine performance differentials among the sub-portfolios as opposed to the sample portfolio; the sample portfolio served as a baseline for the analysis. The analysis noted that the portfolios that were large and had lower debt (leverage) were, on average, of a higher performance and that that performance was more stable over time relative to other portfolios and the sample portfolio. The findings thus suggest that, for portfolios of large size, marginal debt levels facilitate the attainment of superior performance. The indicator analysis also confirmed that Jensen’s alpha was the most effective metric to identify and confirm performance differentiation, likely due to that performance being superior. To improve portfolio performance efficiency within a volatile economy, the study encourages investment strategies that reduce portfolio leverage focused on large company stock for portfolio managers and investors on the Iraqi Stock Exchange.