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Computing implied returns in a meaningful way

Author

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  • Ulf Herold

    (Applied Research, Metzler Investment)

Abstract

The fact that mean-variance optimisers are highly sensitive to changes in expected returns is well known in investment practice. A common approach is therefore to turn the problem around: instead of starting with a set of expected returns and solving for optimal weights, implied returns are extracted from a given portfolio structure. By comparing the implied returns with the expected returns that an investor might have, the portfolio weights can be changed in an iterative way. The difficulty is that there is no unique set of implied returns. This paper shows that the common procedure of determining the implied returns will often lead to unreasonable values, and it provides a modification that results in sensible and more realistic implied returns.

Suggested Citation

  • Ulf Herold, 2005. "Computing implied returns in a meaningful way," Journal of Asset Management, Palgrave Macmillan, vol. 6(1), pages 53-64, June.
    • Handle: RePEc:pal:assmgt:v:6:y:2005:i:1:d:10.1057_palgrave.jam.2240165
    DOI: 10.1057/palgrave.jam.2240165
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    Citations

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    Cited by:

    1. Wolff, Dominik & Bessler, Wolfgang & Opfer, Heiko, 2012. "Multi-Asset Portfolio Optimization and Out-of-Sample Performance: An Evaluation of Black-Litterman, Mean Variance and Naïve Diversification Approaches," VfS Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62020, Verein für Socialpolitik / German Economic Association.
    2. Leon (Liang) Xin & Shanshan Ding, 2021. "Expected returns with leverage constraints and target returns," Journal of Asset Management, Palgrave Macmillan, vol. 22(3), pages 200-208, May.
    3. Dimitris Bertsimas & Vishal Gupta & Ioannis Ch. Paschalidis, 2012. "Inverse Optimization: A New Perspective on the Black-Litterman Model," Operations Research, INFORMS, vol. 60(6), pages 1389-1403, December.
    4. Silva, Thuener & Pinheiro, Plácido Rogério & Poggi, Marcus, 2017. "A more human-like portfolio optimization approach," European Journal of Operational Research, Elsevier, vol. 256(1), pages 252-260.

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