Estimation Risk and Portfolio Selection in the Lower Partial Moment

25 Pages Posted: 25 Jul 2000

Date Written: Undated

Abstract

Portfolio selection models generally assume that the investor knows the parameters of the probability distribution of security returns. In practise the investor must, however, employ estimates of the necessary parameters. In this paper we investigate the effect of estimation risk on the efficient frontier in the lower partial moment framework. The results of the average difference between the actual and estimated portfolios show that the estimated portfolios are biased predictors of the actual portfolios. However, the estimates of the optimal portfolios can be improved. If our concern is the uncertainty in the optimal portfolio weights, then a bootstrap approach should be used to improve the optimizations. On the other hand, if our concern is related to the risk and portfolio mean returns of the optimized portfolios, then a James-Stein approach should be used.

JEL Classification: G12

Suggested Citation

Persson, Mattias, Estimation Risk and Portfolio Selection in the Lower Partial Moment (Undated). Available at SSRN: https://ssrn.com/abstract=233896 or http://dx.doi.org/10.2139/ssrn.233896

Mattias Persson (Contact Author)

Sveriges Riksbank ( email )

Brunkebergstorg 11
SE- 103 37 Stockholm
Sweden

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