Risk Optimizations on Basis Portfolios: The Role of Sorting

45 Pages Posted: 25 May 2018 Last revised: 27 Oct 2020

See all articles by Boris Fays

Boris Fays

University of Liege, HEC Management School

Nicolas A. Papageorgiou

HEC Montreal - Department of Finance

Marie Lambert

University of Liège - HEC Management School

Date Written: April 25, 2020

Abstract

This paper investigates the mean-variance and diversification properties of risk-based strategies performed on style or basis portfolios. We show that the performance of these risk strategies is improved when performed on portfolios sorted on characteristics correlated with returns and is highly sensitive to the sorting procedure used to form the basis assets. Whereas the extant literature provides mixed support for the outperformance of smart beta strategies based on scientific diversification, our designed strategies outperform both the market model and multifactor models. Our testing framework is based on bootstrapped mean-variance spanning tests and shows valid conclusions when controlling for multiple testing, transaction costs, and luck from random basis portfolio construction rules. Economically, our results are supported by diversification-based properties.

Keywords: Bootstrap, Mean-variance efficiency, Portfolio sorting, Risk-based optimization, Smart Beta, Style investing.

JEL Classification: G10, G11

Suggested Citation

Fays, Boris and Papageorgiou, Nicolas A. and Lambert, Marie, Risk Optimizations on Basis Portfolios: The Role of Sorting (April 25, 2020). Available at SSRN: https://ssrn.com/abstract=3179548 or http://dx.doi.org/10.2139/ssrn.3179548

Boris Fays

University of Liege, HEC Management School ( email )

Liège
Belgium

Nicolas A. Papageorgiou

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

Marie Lambert (Contact Author)

University of Liège - HEC Management School ( email )

HEC-Liège
rue Louvrex 14
LIEGE, Liege 4000
Belgium

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