Enhanced Optimal Portfolios - A Controlled Integration of Quantitative Predictors

Abstract:     
No unanimous agreement exists on the optimality of market-capitalization weighted portfolios, nor on the potential benefits of active portfolio management. Starting from the classical Black-Litterman approach, we show that historically generated excess return above the market portfolio can be retained whilst constraining additional downside risk. Weighting factors required for the mixed estimation can be directly derived from predictive regressions in form of the goodness-of-fit measure. This enables an unambiguous determination of certainty levels in a dynamic multi-period framework.

Number of Pages in PDF File: 20

Keywords: Bayesian portfolio construction, Black-Litterman, downside risk, goodness-of-fit, random sampling, enhanced indexing

JEL Classification: C11, C22, C53, C61, D24, G11, G12

working papers series