On Portfolio Optimization: Forecasting Covariances and Choosing the Risk Model

Posted: 13 Mar 2000

See all articles by Louis K.C. Chan

Louis K.C. Chan

University of Illinois at Urbana-Champaign - Department of Finance

Jason J. Karceski

LSV Asset Management

Josef Lakonishok

University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Abstract

We evaluate the performance of models for the covariance structure of stock returns, focusing on their use for optimal portfolio selection. We compare the models' forecasts of future covariances and the optimized portfolios' out-of-sample performance. A few factors capture the general covariance structure. Portfolio optimization helps for risk control, and a three-factor model is adequate for selecting the minimum-variance portfolio. Under a tracking error volatility criterion, which is widely used in practice, larger differences emerge across the models. In general more factors are necessary when the objective is to minimize tracking error volatility.

JEL Classification: G12, G14

Suggested Citation

Chan, Louis K.C. and Karceski, Jason J. and Lakonishok, Josef, On Portfolio Optimization: Forecasting Covariances and Choosing the Risk Model. As Published in Review of Financial Studies, Volume 12, Issue 5. Available at SSRN: https://ssrn.com/abstract=184674

Louis K.C. Chan (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
217-333-6391 (Phone)
217-244-3102 (Fax)

Jason J. Karceski

LSV Asset Management ( email )

155 N Wacker Dr.
Chicago, IL 60654
United States
352-246-7674 (Phone)

Josef Lakonishok

University of Illinois at Urbana-Champaign ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
217-333-7185 (Phone)
217-244-3102 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Register to save articles to
your library

Register

Paper statistics

Abstract Views
1,816
PlumX Metrics