Mean-Variance Investing

Abstract

Mean-variance investing is all about diversification. Diversification considers assets holistically and exploits the interaction of assets with each other, rather than viewing assets in isolation. Holding a diversified portfolio allows investors to increase expected returns while reducing risks. In practice, mean-variance portfolios that constrain the mean, volatility, and correlation inputs to reduce sampling error have performed much better than unconstrained portfolios. These special cases include equal-weighted, minimum variance, and risk parity portfolios.

Keywords: Diversification, efficient frontier, free lunch, non-participation, risk parity, volatility weighting, estimation risk

JEL Classification: G11, G12