Eigen Portfolio Selection: A Robust Approach to Sharpe Ratio Maximization

56 Pages Posted: 16 Nov 2017 Last revised: 31 Oct 2018

See all articles by Danqiao Guo

Danqiao Guo

University of Waterloo

Phelim P. Boyle

Wilfrid Laurier University - School of Business & Economics; University of Waterloo

Chengguo Weng

University of Waterloo

Tony S. Wirjanto

University of Waterloo - School of Accounting and Finance; University of Waterloo, Department of Statistics & Actuarial Science

Date Written: April 1, 2018

Abstract

We show that even when a covariance matrix is poorly estimated, it is still possible to obtain a robust maximum Sharpe ratio portfolio by exploiting the uneven distribution of estimation errors across principal components. This is accomplished by approximating an investor’s view on future asset returns using a few relatively accurate sample principal components. We discuss two approximation methods. The first method leads to a subtle connection to existing approaches in the literature; while the second one is novel and able to address main shortcomings of existing methods.

Keywords: Portfolio optimization, Estimation error, Approximation error, Spectral cut-off method, Spectral selection method

JEL Classification: G11

Suggested Citation

Guo, Danqiao and Boyle, Phelim P. and Weng, Chengguo and Wirjanto, Tony S., Eigen Portfolio Selection: A Robust Approach to Sharpe Ratio Maximization (April 1, 2018). Available at SSRN: https://ssrn.com/abstract=3070416 or http://dx.doi.org/10.2139/ssrn.3070416

Danqiao Guo (Contact Author)

University of Waterloo ( email )

Waterloo, Ontario N2L 3G1
Canada

Phelim P. Boyle

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
Canada
519 884 1970 (Phone)
519 888 1015 (Fax)

University of Waterloo

Waterloo, Ontario N2L 3G1
Canada

Chengguo Weng

University of Waterloo ( email )

M3-200 Univ Ave W
Waterloo, Ontario N2L3G1
Canada
(1)888-4567 ext.31132 (Phone)

Tony S. Wirjanto

University of Waterloo - School of Accounting and Finance ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1
Canada
519-888-4567 x35210 (Phone)

HOME PAGE: http://https://uwaterloo.ca/statistics-and-actuarial-science/people-profiles/tony-wirjanto

University of Waterloo, Department of Statistics & Actuarial Science ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1
Canada
519-888-4567 x35210 (Phone)
519-746-1875 (Fax)

HOME PAGE: http://math.uwaterloo.ca/statistics-and-actuarial-science/people-profiles/tony-wirjanto

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