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Optimal Portfolio Choice with Estimation Risk: No Risk-Free Asset Case

Author

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  • Raymond Kan

    (Rotman School of Management, University of Toronto, Toronto, Ontario M5S 3E6, Canada)

  • Xiaolu Wang

    (Ivy College of Business, Iowa State University, Ames, Iowa 50011)

  • Guofu Zhou

    (Olin School of Business, Washington University in St. Louis, St. Louis, Missouri 63130; CAFR, Shanghai 200030, China)

Abstract

We propose an optimal combining strategy to mitigate estimation risk for the popular mean-variance portfolio choice problem in the case without a risk-free asset. We find that our strategy performs well in general, and it can be applied to known estimated rules and the resulting new rules outperform the original ones. We further obtain the exact distribution of the out-of-sample returns and explicit expressions of the expected out-of-sample utilities of the combining strategy, providing not only a fast and accurate way of evaluating the performance, but also analytical insights into the portfolio construction.

Suggested Citation

  • Raymond Kan & Xiaolu Wang & Guofu Zhou, 2022. "Optimal Portfolio Choice with Estimation Risk: No Risk-Free Asset Case," Management Science, INFORMS, vol. 68(3), pages 2047-2068, March.
  • Handle: RePEc:inm:ormnsc:v:68:y:2022:i:3:p:2047-2068
    DOI: 10.1287/mnsc.2021.3989
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    References listed on IDEAS

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    Cited by:

    1. Kan, Raymond & Lassance, Nathan & Wang, Xiaolu, 2023. "The distribution of sample mean-variance portfolio weights," LIDAM Discussion Papers LFIN 2023006, Université catholique de Louvain, Louvain Finance (LFIN).
    2. Huang, Zhenzhen & Wei, Pengyu & Weng, Chengguo, 2024. "Tail mean-variance portfolio selection with estimation risk," Insurance: Mathematics and Economics, Elsevier, vol. 116(C), pages 218-234.
    3. Hongxin Zhao & Yilun Jiang & Yizhou Yang, 2023. "Robust and Sparse Portfolio: Optimization Models and Algorithms," Mathematics, MDPI, vol. 11(24), pages 1-20, December.
    4. Lassance, Nathan & Vrins, Frédéric, 2023. "Portfolio selection: A target-distribution approach," European Journal of Operational Research, Elsevier, vol. 310(1), pages 302-314.
    5. Collin Gilstrap & Alex Petkevich & Pavel Teterin & Kainan Wang, 2024. "Lever up! An analysis of options trading in leveraged ETFs," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 44(6), pages 986-1002, June.
    6. Kan, Raymond & Wang, Xiaolu & Zheng, Xinghua, 2024. "In-sample and out-of-sample Sharpe ratios of multi-factor asset pricing models," Journal of Financial Economics, Elsevier, vol. 155(C).
    7. Ko, Hyungjin & Son, Bumho & Lee, Jaewook, 2024. "A novel integration of the Fama–French and Black–Litterman models to enhance portfolio management," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 91(C).

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