Sparse Mean-Variance Portfolios: A Penalized Utility Approach

Abstract

This paper considers mean-variance optimization under uncertainty, specifically when one desires a sparsified set of optimal portfolio weights. From the standpoint of a Bayesian investor, our approach produces a small portfolio from many potential assets while acknowledging uncertainty in asset returns and parameter estimates. We demonstrate the procedure using static and dynamic models for asset returns.

Keywords: portfolio optimization, passive investing, mean-variance optimization, decoupling shrinkage and selection

JEL Classification: C11, C61