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Can robust portfolio optimisation help to build better portfolios?

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  • Bernd Scherer

    (Managing Director, Morgan Stanley, IM-Alternative Investments)

Abstract

Estimation error has always been acknowledged as a substantial problem in portfolio construction. Various approaches exist that range from Bayesian methods with a very strong rooting in decision theory to practitioner-based heuristics with no rooting in decision theory at all as portfolio resampling. Robust optimisation is the latest attempt to address estimation error directly in the portfolio construction process. It will be shown that robust optimisation is equivalent to Bayesian shrinkage estimators and offer no marginal value relative to the former. The implied shrinkage that comes with robust optimisation is difficult to control. Consistent with the ad hoc treatment of uncertainty aversion in robust optimisation, it can be seen that out of sample performance largely depends on the appropriate choice of uncertainty aversion, with no guideline on how to calibrate this parameter or how to make it consistent with the more well-known risk aversion.

Suggested Citation

  • Bernd Scherer, 2007. "Can robust portfolio optimisation help to build better portfolios?," Journal of Asset Management, Palgrave Macmillan, vol. 7(6), pages 374-387, March.
    • Handle: RePEc:pal:assmgt:v:7:y:2007:i:6:d:10.1057_palgrave.jam.2250049
    DOI: 10.1057/palgrave.jam.2250049
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    Citations

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    Cited by:

    1. Jang Ho Kim & Yongjae Lee & Woo Chang Kim & Frank J. Fabozzi, 2022. "Goal-based investing based on multi-stage robust portfolio optimization," Annals of Operations Research, Springer, vol. 313(2), pages 1141-1158, June.
    2. Eduard Baitinger & Samuel Flegel, 2021. "The better turbulence index? Forecasting adverse financial markets regimes with persistent homology," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 35(3), pages 277-308, September.
    3. Antonios Georgantas & Michalis Doumpos & Constantin Zopounidis, 2024. "Robust optimization approaches for portfolio selection: a comparative analysis," Annals of Operations Research, Springer, vol. 339(3), pages 1205-1221, August.
    4. Pierre O. De souza & Tiago P. Filomena & João F. Caldeira & Denis Borenstein & Marcelo B. Righi, 2017. "Risk parity in the brazilian market," Economics Bulletin, AccessEcon, vol. 37(3), pages 1555-1566.
    5. Alireza Ghahtarani & Ahmed Saif & Alireza Ghasemi, 2021. "Robust Portfolio Selection Problems: A Comprehensive Review," Papers 2103.13806, arXiv.org, revised Jan 2022.
    6. André Alves Portela Santos, 2010. "The Out-of-Sample Performance of Robust Portfolio Optimization," Brazilian Review of Finance, Brazilian Society of Finance, vol. 8(2), pages 141-166.
    7. Yu, Jing-Rung & Paul Chiou, Wan-Jiun & Hsin, Yi-Ting & Sheu, Her-Jiun, 2022. "Omega portfolio models with floating return threshold," International Review of Economics & Finance, Elsevier, vol. 82(C), pages 743-758.
    8. Kellerer, Belinda, 2019. "Portfolio Optimization and Ambiguity Aversion," Junior Management Science (JUMS), Junior Management Science e. V., vol. 4(3), pages 305-338.
    9. Bernd Scherer, 2021. "Adding alternative assets: return enhancement, diversification or hedging?," Journal of Asset Management, Palgrave Macmillan, vol. 22(6), pages 437-442, October.
    10. Shashank Oberoi & Mohammed Bilal Girach & Siddhartha P. Chakrabarty, 2020. "Can Robust Optimization Offer Improved Portfolio Performance? An Empirical Study of Indian market," Journal of Quantitative Economics, Springer;The Indian Econometric Society (TIES), vol. 18(3), pages 611-630, September.
    11. Ramesh Adhikari & Kyle J. Putnam & Humnath Panta, 2020. "Robust Optimization-Based Commodity Portfolio Performance," IJFS, MDPI, vol. 8(3), pages 1-16, September.
    12. Jang Ho Kim & Woo Chang Kim & Frank J. Fabozzi, 2014. "Recent Developments in Robust Portfolios with a Worst-Case Approach," Journal of Optimization Theory and Applications, Springer, vol. 161(1), pages 103-121, April.
    13. Woo Kim & Jang Kim & So Ahn & Frank Fabozzi, 2013. "What do robust equity portfolio models really do?," Annals of Operations Research, Springer, vol. 205(1), pages 141-168, May.
    14. Francisco Rubio & Xavier Mestre & Daniel P. Palomar, 2011. "Performance analysis and optimal selection of large mean-variance portfolios under estimation risk," Papers 1110.3460, arXiv.org.
    15. Panos Xidonas & Ralph Steuer & Christis Hassapis, 2020. "Robust portfolio optimization: a categorized bibliographic review," Annals of Operations Research, Springer, vol. 292(1), pages 533-552, September.
    16. Jang Ho Kim & Woo Chang Kim & Do-Gyun Kwon & Frank J. Fabozzi, 2018. "Robust equity portfolio performance," Annals of Operations Research, Springer, vol. 266(1), pages 293-312, July.
    17. Gabriel Frahm, 2015. "A theoretical foundation of portfolio resampling," Theory and Decision, Springer, vol. 79(1), pages 107-132, July.
    18. Chakrabarti, Deepayan, 2021. "Parameter-free robust optimization for the maximum-Sharpe portfolio problem," European Journal of Operational Research, Elsevier, vol. 293(1), pages 388-399.
    19. Zhilin Kang & Zhongfei Li, 2018. "An exact solution to a robust portfolio choice problem with multiple risk measures under ambiguous distribution," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 87(2), pages 169-195, April.
    20. Shashank Oberoi & Mohammed Bilal Girach & Siddhartha P. Chakrabarty, 2019. "Can robust optimization offer improved portfolio performance?: An empirical study of Indian market," Papers 1908.04962, arXiv.org.
    21. David King, 2007. "Portfolio optimisation and diversification," Journal of Asset Management, Palgrave Macmillan, vol. 8(5), pages 296-307, December.
    22. Kolm, Petter N. & Tütüncü, Reha & Fabozzi, Frank J., 2014. "60 Years of portfolio optimization: Practical challenges and current trends," European Journal of Operational Research, Elsevier, vol. 234(2), pages 356-371.
    23. Kaiqiang An & Guiyu Zhao & Jinjun Li & Jingsong Tian & Lihua Wang & Liang Xian & Chen Chen, 2023. "Best-Case Scenario Robust Portfolio: Evidence from China Stock Market," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 30(2), pages 297-322, June.
    24. Aït-Sahalia, Yacine & Matthys, Felix, 2019. "Robust consumption and portfolio policies when asset prices can jump," Journal of Economic Theory, Elsevier, vol. 179(C), pages 1-56.
    25. Alireza Ghahtarani & Ahmed Saif & Alireza Ghasemi, 2022. "Robust portfolio selection problems: a comprehensive review," Operational Research, Springer, vol. 22(4), pages 3203-3264, September.

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