A Stability Approach to Mean‐Variance Optimization

30 Pages Posted: 17 Jul 2015

See all articles by Apostolos Kourtis

Apostolos Kourtis

University of East Anglia (UEA) - Norwich Business School

Multiple version iconThere are 2 versions of this paper

Date Written: August 2015

Abstract

I jointly treat two critical issues in the application of mean‐variance portfolios, that is, estimation risk and portfolio instability. I find that theory‐based portfolio strategies, which are known to outperform naive diversification (1/V) in the absence of transaction costs, heavily underperform it under transaction costs. This is because they are highly unstable over time. I propose a generic method to stabilize any given portfolio strategy while maintaining or improving its efficiency. My empirical analysis confirms that the new method leads to stable and efficient portfolios that offer equal or lower turnover than and larger Sharpe ratio, even under high transaction costs.

Keywords: portfolio choice, stability, estimation risk, transaction costs

JEL Classification: C13, C51, C61, G11

Suggested Citation

Kourtis, Apostolos, A Stability Approach to Mean‐Variance Optimization (August 2015). Financial Review, Vol. 50, Issue 3, pp. 301-330, 2015. Available at SSRN: https://ssrn.com/abstract=2631831 or http://dx.doi.org/10.1111/fire.12068

Apostolos Kourtis (Contact Author)

University of East Anglia (UEA) - Norwich Business School ( email )

Norwich
NR4 7TJ
United Kingdom

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