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

Posted: 4 Dec 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: November 18, 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 portfolios that are subject to high estimation risk and extreme turnover. We find that mean-variance optimization often outperforms naive diversification, but turnover can erode its advantage in the presence of transactions costs. To address this issue, we develop two new methods of mean-variance portfolio selection – volatility timing and reward-to-risk timing – that deliver portfolios characterized by low turnover. These timing strategies outperform naive diversification even in the presence of high transactions costs.

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 (November 18, 2010). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1718845

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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