Asset Allocation with Correlation: A Composite Trade-Off

European Journal of Operational Research, Forthcoming

40 Pages Posted: 8 Apr 2017

See all articles by Rachael Carroll

Rachael Carroll

Trinity College (Dublin)

Thomas Conlon

University College Dublin

John Cotter

University College Dublin; UCLA Anderson School of Management

Enrique Salvador

Universitat Jaume I - Department of Finance and Accounting

Date Written: April 6, 2017

Abstract

We assess the ability of minimum-variance portfolio allocation strategies accounting for time-varying correlation between assets to provide performance benefits relative to an equally-weighted portfolio. Prior to transaction costs correlation-based strategies emphatically outperform the equally-weighted benchmark. This finding is strongest for short horizon correlation forecasts and attributed to dynamic correlation as opposed to variance forecasts. Thus, estimation error is not found to be the primary obstacle to successful portfolio optimization. Rather, frequent rebalancing and associated transaction costs pose a significant challenge. Limiting portfolio turnover through short-selling restrictions and greater rebalancing error tolerance results in regular outperformance of the correlation based strategies even for large transaction costs. Taken together, these findings provide evidence of a trade-off between optimal portfolio performance, forecasting horizon, rebalancing frequency and transaction costs.

Keywords: Decision Analysis, Optimization, Asset Allocation, Dynamic Correlation, Rebalancing & Transaction Costs

JEL Classification: G11; C44; C01; C22

Suggested Citation

Carroll, Rachael and Conlon, Thomas and Cotter, John and Salvador, Enrique, Asset Allocation with Correlation: A Composite Trade-Off (April 6, 2017). European Journal of Operational Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2947643

Rachael Carroll

Trinity College (Dublin) ( email )

2-3 College Green
Dublin, Leinster
Ireland

Thomas Conlon (Contact Author)

University College Dublin ( email )

Smurfit Graduate Business School
Blackrock
Co. Dublin, n/a
Ireland

HOME PAGE: http://www.ucd.ie/bankingfinance/staff/drthomasconlon/

John Cotter

University College Dublin ( email )

School of Business, Carysfort Avenue
Blackrock, Co. Dublin
Ireland
353 1 716 8900 (Phone)
353 1 283 5482 (Fax)

HOME PAGE: http://www.ucd.ie/bankingfinance/staff/professorjohncotter/

UCLA Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Enrique Salvador

Universitat Jaume I - Department of Finance and Accounting ( email )

Castellon
E-12071 Castello de la Plana, Castellón de la Plana 12071
Spain

Register to save articles to
your library

Register

Paper statistics

Downloads
223
rank
131,017
Abstract Views
924
PlumX Metrics