Partial Index Tracking enhanced Mean-Variance Portfolio

Forthcoming in International Journal of Finance & Economics

37 Pages Posted: 5 May 2021 Last revised: 7 Mar 2024

See all articles by Zhaokun Cai

Zhaokun Cai

Stevens Institute of Technology - School of Business

Zhenyu Cui

Stevens Institute of Technology - School of Business

Majeed Simaan

Stevens Institute of Technology - School of Business

Date Written: March 5, 2024

Abstract

Estimation constitutes a major challenge in the implementation of mean-variance portfolios. To overcome this, we propose a partial index-tracking strategy that aims to mitigate estimation error ex-ante. Theoretically, we minimize the mean-squared error of the proposed strategy by shrinking the portfolio variance to its tracking error. Using an empirical innovation with over 50 years of data, our paper makes two important observations. First, we show that our proposed approach is consistent with both linear and non-linear shrinkage strategies in terms of robustness. Second, the proposed decision rule leads to a lower out-of-sample tracking error. Our findings, overall, stress the appeal of partial-index tracking not only in terms of shrinkage (robustness) but also in terms of relative performance.

Keywords: Portfolio Optimization, Index Tracking, Parameter Estimation Risk

JEL Classification: C13, C61, G11, G12

Suggested Citation

Cai, Zhaokun and Cui, Zhenyu and Simaan, Majeed, Partial Index Tracking enhanced Mean-Variance Portfolio (March 5, 2024). Forthcoming in International Journal of Finance & Economics , Available at SSRN: https://ssrn.com/abstract=3837397 or http://dx.doi.org/10.2139/ssrn.3837397

Zhaokun Cai

Stevens Institute of Technology - School of Business

Hoboken, NJ 07030
United States

Zhenyu Cui (Contact Author)

Stevens Institute of Technology - School of Business ( email )

Hoboken, NJ 07030
United States

HOME PAGE: http://sites.google.com/site/zhenyucui86/publications

Majeed Simaan

Stevens Institute of Technology - School of Business ( email )

Hoboken, NJ 07030
United States

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