It’s All in the Timing: Simple Active Portfolio Strategies that Outperform Naive Diversification

43 Pages Posted: 1 Jan 2010 Last revised: 13 May 2010

See all articles by Chris Kirby

Chris Kirby

UNC Charlotte - Belk College of Business

Barbara Ostdiek

Rice University - Jesse H. Jones Graduate School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: May 9, 2010

Abstract

DeMiguel et al. (2009) report that naive diversification dominates mean-variance optimization in out-of-sample asset allocation tests. Our analysis suggests that this is largely due to their research design, which focuses on mean-variance efficient portfolios that are subject to high estimation risk and extreme turnover. We find that mean-variance optimization outperforms naive diversification under many circumstances, but its advantage can easily be eroded by transactions costs. This motivates us to propose two types of mean-variance timing strategies, both characterized by low turnover. These strategies outperform naive diversification even in the presence of relatively high transactions costs. In contrast to DeMiguel et al. (2009), therefore, we conclude that using sample information to guide portfolio selection yields substantial benefits.

Keywords: portfolio selection, mean-variance optimization, estimation risk, turnover, market timing, volatility timing

JEL Classification: G11, G12, C11

Suggested Citation

Kirby, Chris and Ostdiek, Barbara, It’s All in the Timing: Simple Active Portfolio Strategies that Outperform Naive Diversification (May 9, 2010). Available at SSRN: https://ssrn.com/abstract=1530022 or http://dx.doi.org/10.2139/ssrn.1530022

Chris Kirby (Contact Author)

UNC Charlotte - Belk College of Business ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

Barbara Ostdiek

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States
713-348-5384 (Phone)
713-348-5251 (Fax)

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