Parametric Portfolio Policies: Exploiting Characteristics in the Cross-Section of Equity Returns

Posted: 8 Sep 2009

See all articles by Michael W. Brandt

Michael W. Brandt

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Pedro Santa-Clara

New University of Lisbon - Nova School of Business and Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Rossen I. Valkanov

University of California, San Diego (UCSD) - Rady School of Management

Multiple version iconThere are 3 versions of this paper

Date Written: September 2009

Abstract

We propose a novel approach to optimizing portfolios with large numbers of assets. We model directly the portfolio weight in each asset as a function of the asset's characteristics. The coefficients of this function are found by optimizing the investor's average utility of the portfolio's return over the sample period. Our approach is computationally simple and easily modified and extended to capture the effect of transaction costs, for example, produces sensible portfolio weights, and offers robust performance in and out of sample. In contrast, the traditional approach of first modeling the joint distribution of returns and then solving for the corresponding optimal portfolio weights is not only difficult to implement for a large number of assets but also yields notoriously noisy and unstable results. We present an empirical implementation for the universe of all stocks in the CRSP-Compustat data set, exploiting the size, value, and momentum anomalies.

Keywords: G11, G12

Suggested Citation

Brandt, Michael W. and Santa-Clara, Pedro and Valkanov, Rossen, Parametric Portfolio Policies: Exploiting Characteristics in the Cross-Section of Equity Returns (September 2009). The Review of Financial Studies, Vol. 22, Issue 9, pp. 3411-3447, 2009. Available at SSRN: https://ssrn.com/abstract=1468198 or http://dx.doi.org/hhp003

Michael W. Brandt (Contact Author)

Duke University - Fuqua School of Business ( email )

1 Towerview Drive
Durham, NC 27708-0120
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Pedro Santa-Clara

New University of Lisbon - Nova School of Business and Economics ( email )

Lisbon
Portugal

HOME PAGE: http://docentes.fe.unl.pt/~psc/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Rossen Valkanov

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States
858-534-0898 (Phone)

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