Abstract

http://ssrn.com/abstract=1307423
 
 

References (38)



 
 

Citations (6)



 


 



Asset Allocation and Risk Assessment with Gross Exposure Constraints for Vast Portfolios


Jianqing Fan


Princeton University - Bendheim Center for Finance

Jingjin Zhang


Princeton University - Bendheim Center for Finance

Ke Yu


Princeton University - Bendheim Center for Finance

November 26, 2008


Abstract:     
Markowitz (1952, 1959) laid down the ground-breaking work on the mean-variance analysis. Under his framework, the theoretical optimal allocation vector can be very different from the estimated one for large portfolios due to the intrinsic difficulty of estimating a vast covariance matrix and return vector. This can result in adverse performance in portfolio selected based on empirical data due to the accumulation of estimation errors. We address this problem by introducing the gross-exposure constrained mean-variance portfolio selection. We show that with gross-exposure constraint the empirically selected optimal portfolios based on estimated covariance matrices have similar performance to the theoretical optimal portfolios and there is no error accumulation effect from estimation of vast covariance matrices. This gives theoretical justification to the empirical results in Jagannathan and Ma (2003). We also show that the no-short-sale portfolio is not diversified enough and can be improved by allowing some short positions. As the constraint on short sales relaxes, the number of selected assets gradually increases and finally reaches the total number of stocks when tracking portfolios or selecting assets. This achieves the optimal sparse portfolio selection, which has close performance to the theoretical optimal one. Among 1000 stocks, for example, we are able to identify all optimal subsets of portfolios of different sizes, their associated allocation vectors, and their estimated risks. The utility of our new approach is illustrated by simulation and empirical studies on the 100 Fama-French industrial portfolios and the 600 stocks randomly selected from Russell 3000.

Number of Pages in PDF File: 41

Keywords: Short-sale constraint, mean-variance efficiency, portfolio selection, risk assessment, risk optimization, portfolio improvement

working papers series





Download This Paper

Date posted: March 14, 2009 ; Last revised: March 22, 2009

Suggested Citation

Fan, Jianqing and Zhang, Jingjin and Yu, Ke, Asset Allocation and Risk Assessment with Gross Exposure Constraints for Vast Portfolios (November 26, 2008). Available at SSRN: http://ssrn.com/abstract=1307423 or http://dx.doi.org/10.2139/ssrn.1307423

Contact Information

Jianqing Fan (Contact Author)
Princeton University - Bendheim Center for Finance ( email )
26 Prospect Avenue
Princeton, NJ 08540
United States
609-258-7924 (Phone)
609-258-8551 (Fax)
HOME PAGE: http://orfe.princeton.edu/~jqfan/
Jingjin Zhang
Princeton University - Bendheim Center for Finance ( email )
26 Prospect Avenue
Princeton, NJ 08540
United States
Ke Yu
Princeton University - Bendheim Center for Finance ( email )
26 Prospect Avenue
Princeton, NJ 08540
United States
Feedback to SSRN


Paper statistics
Abstract Views: 3,547
Downloads: 1,125
Download Rank: 9,693
References:  38
Citations:  6

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo7 in 0.266 seconds