Outperforming Naive Diversification Using Stock Level Information

50 Pages Posted: 21 Aug 2015 Last revised: 7 Jan 2016

See all articles by Tony Berrada

Tony Berrada

University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute

Sebastien Coupy

University of Geneva; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Date Written: October 1, 2015

Abstract

We construct mean-variance portfolios using a factor model approach. We show the importance of portfolio allocation for large unbalanced equity data sets using the full CRSP database. We compare the performance of our portfolio construction methodology to the 1/N naive diversification strategy, standard shrinkage procedures, and alternative factor model estimation. We document significant out-of-sample performance improvement in terms of Sharpe ratios, turnover and certainty equivalent. We show that it is due to improved expected returns estimation coming from the 2-pass regression approach.

Keywords: Mean-Variance, factor model, optimization, 2 stage least square

JEL Classification: G11

Suggested Citation

Berrada, Tony and Coupy, Sebastien, Outperforming Naive Diversification Using Stock Level Information (October 1, 2015). Swiss Finance Institute Research Paper No. 15-32. Available at SSRN: https://ssrn.com/abstract=2647354 or http://dx.doi.org/10.2139/ssrn.2647354

Tony Berrada

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, 1211
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Sebastien Coupy (Contact Author)

University of Geneva ( email )

102 Bd Carl-Vogt
Genève, GA CH - 1205
Switzerland

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

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