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How Does the Ledoit and Wolf Shrinkage Estimator Improve a Real Estate Portfolio?

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  • Eric Vu Anh Tuan

Abstract

Portfolio theories are meant to provide a method for managing assets and constructing portfolios. Meanwhile, the mean-variance technique has been heavily criticized by some academics, and its application to real estate portfolio is questionable (Cheng and Liang, 2000). Indeed, the mean-variance analysis is quite sensitive to estimation errors, and traditional real estate databases can represent a huge pitfall to portfolio construction. Therefore, we look for a method to lessen the effect of inputs upon the optimization process; the shrinkage estimator appears to show some advantages in modeling real estate portfolios. This study employs the shrinkage estimator scheme of Ledoit and Wolf (2004) to examine the effect of a corner solution on the allocations. This process limits the impact of estimation errors on the optimization process, resulting in a distinctive investment strategy.

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  • Eric Vu Anh Tuan, 2013. "How Does the Ledoit and Wolf Shrinkage Estimator Improve a Real Estate Portfolio?," Journal of Real Estate Portfolio Management, Taylor & Francis Journals, vol. 19(1), pages 89-101, January.
    • Handle: RePEc:taf:repmxx:v:19:y:2013:i:1:p:89-101
    DOI: 10.1080/10835547.2013.12089937
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