Optimal Portfolio Choice with Estimation Risk: No Risk-free Asset Case

52 Pages Posted: 10 Feb 2016 Last revised: 29 Oct 2018

See all articles by Raymond Kan

Raymond Kan

University of Toronto - Rotman School of Management

Xiaolu Wang

Iowa State University

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School; China Academy of Financial Research (CAFR)

Date Written: October 27, 2018

Abstract

For the popular mean-variance portfolio choice problem in the case without a risk-free asset, we develop a new optimal portfolio rule that is designed to mitigate estimation risk. We compare its out-of-sample performance, both theoretically and empirically, with that of other portfolio rules. In both calibrations and real datasets, we show that our new rule performs well relative to others. Our results suggest the importance of explicitly taking into account the impact of estimation risk when forming an optimal portfolio. In addition, we derive the exact distribution of the out-of-sample returns and provide the explicit expression of the out-of-sample expected utility of various optimal portfolio rules, which offers analytical insights into portfolio construction and performance evaluation.

Keywords: portfolio choice, estimation risk, global minimum-variance portfolio, 1/N rule

JEL Classification: G11, G12, C11

Suggested Citation

Kan, Raymond and Wang, Xiaolu and Zhou, Guofu, Optimal Portfolio Choice with Estimation Risk: No Risk-free Asset Case (October 27, 2018). Rotman School of Management Working Paper No. 2819254; 29th Australasian Finance and Banking Conference 2016; Rotman School of Management Working Paper No. 2819254. Available at SSRN: https://ssrn.com/abstract=2819254 or http://dx.doi.org/10.2139/ssrn.2819254

Raymond Kan

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S3E6
Canada
416-978-4291 (Phone)
416-971-3048 (Fax)

Xiaolu Wang (Contact Author)

Iowa State University ( email )

613 Wallace Road
Ames, IA 50011-2063
United States

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School ( email )

Washington University
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6384 (Phone)
314-658-6359 (Fax)

HOME PAGE: http://apps.olin.wustl.edu/faculty/zhou/

China Academy of Financial Research (CAFR)

Shanghai Advanced Institute of Finance
Shanghai P.R.China, 200030
China

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