Abstract

http://ssrn.com/abstract=1126596
 
 

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Using Economic Theory to Build Optimal Portfolios


Thomas Chevrier


University of Chicago - Booth School of Business

Robert E. McCulloch


University of Chicago - Booth School of Business

April 24, 2008


Abstract:     
Given expected returns and return covariances, portfolio weights are known in closed form in a mean-variance framework. The real difficulty is in estimating these parameters. Using recent advances in Bayesian techniques, we show how investors can incorporate any prior information for optimal portfolio selection. We apply our method to 27 domestic and international data sets. We find that our tangency portfolios have three essential and attractive features. i) They perform better in terms of out-of-sample Sharpe ratio. ii) Their weights are guaranteed to be economically "reasonable": positive, stable, and without extravagant position in any asset. iii) Turnover is very low.

Number of Pages in PDF File: 39

JEL Classification: C11, C13, C15, G11, G12

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Date posted: April 30, 2008  

Suggested Citation

Chevrier, Thomas and McCulloch, Robert E., Using Economic Theory to Build Optimal Portfolios (April 24, 2008). Available at SSRN: http://ssrn.com/abstract=1126596 or http://dx.doi.org/10.2139/ssrn.1126596

Contact Information

Thomas Chevrier (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
Robert E. McCulloch
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
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