Premium
How much should portfolios shrink?
Author(s) -
Han Chulwoo
Publication year - 2019
Publication title -
financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.647
H-Index - 68
eISSN - 1755-053X
pISSN - 0046-3892
DOI - 10.1111/fima.12282
Subject(s) - portfolio , portfolio optimization , transaction cost , computer science , econometrics , post modern portfolio theory , merton's portfolio problem , modern portfolio theory , replicating portfolio , economics , financial economics , microeconomics
This paper develops a portfolio model that penalizes the deviation from a reference portfolio. The proposed model renders a robust portfolio that performs superior under parameter uncertainty. Penalizing the deviation also improves the performance of existing shrinkage portfolio models that are suboptimal due to model parameter uncertainty. The equal‐weight portfolio turns out to be a better reference portfolio than the currently holding portfolio even in the presence of transaction costs. A data‐driven method for determining the degree of penalization is offered. Comprehensive simulation and empirical studies suggest that the proposed model significantly outperforms various existing models.