On Portfolio Optimization: Imposing the Right Constraints

37 Pages Posted: 2 Jun 2010 Last revised: 8 Jan 2019

See all articles by Patrick Behr

Patrick Behr

Getulio Vargas Foundation (FGV) - Brazilian School of Public and Business Administration (EBAPE)

Andre Guettler

Ulm University - Department of Mathematics and Economics; Halle Institute for Economic Research

Felix Miebs

University of Applied Sciences Cologne

Date Written: November 26, 2012

Abstract

We reassess the recent finding that no established portfolio strategy outperforms the naively diversified portfolio, 1/N, by developing a constrained minimum-variance portfolio strategy on a shrinkage theory based framework. Our results show that our constrained minimum-variance portfolio yields significantly lower out-of-sample variances than many established minimum-variance portfolio strategies. Further, we observe that our portfolio strategy achieves higher Sharpe ratios than 1/N, amounting to an average Sharpe ratio increase of 32.5% across our six empirical datasets. We find that our constrained minimum-variance strategy is the only strategy that achieves the goal of improving the Sharpe ratio of 1/N consistently and significantly. At the same time, our developed portfolio strategy achieves a comparatively low turnover and exhibits no excessive short interest.

Keywords: Portfolio Optimization, Shrinkage, Mean Squared Error, Bootstrap

JEL Classification: G11

Suggested Citation

Behr, Patrick and Guettler, Andre and Miebs, Felix, On Portfolio Optimization: Imposing the Right Constraints (November 26, 2012). Journal of Banking & Finance 37 (2013), 1232–1242, Available at SSRN: https://ssrn.com/abstract=1618756 or http://dx.doi.org/10.2139/ssrn.1618756

Patrick Behr

Getulio Vargas Foundation (FGV) - Brazilian School of Public and Business Administration (EBAPE) ( email )

Brazil

Andre Guettler (Contact Author)

Ulm University - Department of Mathematics and Economics ( email )

Helmholzstrasse
Ulm, D-89081
Germany

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

Felix Miebs

University of Applied Sciences Cologne ( email )

Claudiusstrasse 1
Cologne, 50678
United States

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