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Global minimum variance portfolio optimisation under some model risk: A robust regression-based approach

Maillet, Bertrand B.; Tokpavi, Sessi; Vaucher, Benoit (2015), Global minimum variance portfolio optimisation under some model risk: A robust regression-based approach, European Journal of Operational Research, 244, 1, p. 289-299. http://dx.doi.org/10.1016/j.ejor.2015.01.010

Type
Article accepté pour publication ou publié
Date
2015
Journal name
European Journal of Operational Research
Volume
244
Number
1
Publisher
Elsevier
Pages
289-299
Publication identifier
http://dx.doi.org/10.1016/j.ejor.2015.01.010
Metadata
Show full item record
Author(s)
Maillet, Bertrand B.

Tokpavi, Sessi

Vaucher, Benoit
Abstract (EN)
The global minimum variance portfolio computed using the sample covariance matrix is known to be negatively affected by parameter uncertainty, an important component of model risk. Using a robust approach, we introduce a portfolio rule for investors who wish to invest in the global minimum variance portfolio due to its strong historical track record, but seek a rule that is robust to parameter uncertainty. Our robust portfolio corresponds theoretically to the global minimum variance portfolio in the worst-case scenario, with respect to a set of plausible alternative estimators of the covariance matrix, in the neighbourhood of the sample covariance matrix. Hence, it provides protection against errors in the reference sample covariance matrix. Monte Carlo simulations illustrate the dominance of the robust portfolio over its non-robust counterpart, in terms of portfolio stability, variance and risk-adjusted returns. Empirically, we compare the out-of-sample performance of the robust portfolio to various competing minimum variance portfolio rules in the literature. We observe that the robust portfolio often has lower turnover and variance and higher Sharpe ratios than the competing minimum variance portfolios.
Subjects / Keywords
Global minimum variance portfolio; Model risk; Parameter uncertainty; Robust least squares; Robust portfolio
JEL
D81 - Criteria for Decision-Making under Risk and Uncertainty
G11 - Portfolio Choice; Investment Decisions

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