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Reducing estimation risk in optimal portfolio selection when short sales are allowed
Author(s) -
Alexander Gordon J.,
Baptista Alexandre M.,
Yan Shu
Publication year - 2009
Publication title -
managerial and decision economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.288
H-Index - 51
eISSN - 1099-1468
pISSN - 0143-6570
DOI - 10.1002/mde.1451
Subject(s) - constraint (computer aided design) , portfolio , efficient frontier , estimation , economics , econometrics , selection (genetic algorithm) , investment (military) , sample (material) , portfolio optimization , computer science , financial economics , mathematics , chemistry , geometry , management , chromatography , artificial intelligence , politics , political science , law
The issue of estimation risk is of particular interest to the decision‐making processes of portfolio managers who use long–short investment strategies. Accordingly, our paper explores the question of whether a VaR constraint reduces estimation risk when short sales are allowed. We find that such a constraint notably decreases errors in estimates of the expected return, standard deviation, and VaR of optimal portfolios. Furthermore, optimal portfolios in the presence of the constraint are substantially closer to the ‘true’ efficient frontier than those in its absence. Finally, we provide VaR bounds and confidence levels for the constraint that lead to the best out‐of‐sample performance. Copyright © 2008 John Wiley & Sons, Ltd.