In Defence of Portfolio Optimisation What If We Can Forecast?

32 Pages Posted: 17 May 2019

See all articles by David J Allen

David J Allen

Plato Investment Management; University of Technology, Sydney

Colin Lizieri

University of Cambridge - Department of Land Economy

Stephen E. Satchell

University of Cambridge - Faculty of Economics and Politics

Date Written: April 17, 2019

Abstract

We challenge academic consensus that estimation error makes mean-variance portfolio strategies inferior to passive equal-weighted approaches. We demonstrate analytically, via simulation and empirically that investors endowed with modest forecasting ability benefit substantially from an MV approach. An investor with some forecasting ability improves expected utility by increasing the number of assets considered. We frame our study realistically using budget constraints, transaction costs and out-of-sample testing for a wide range of investments. We derive practical decision rules to choose between passive and mean variance optimisation results and generate results consistent with much financial market practice and the original Markowitz formulation.

Keywords: portfolio optimisation, forecasting ability, asset allocation, mean variance, estimation error

Suggested Citation

Allen, David J and Lizieri, Colin M. and Satchell, Stephen E., In Defence of Portfolio Optimisation What If We Can Forecast? (April 17, 2019). Available at SSRN: https://ssrn.com/abstract=3373594 or http://dx.doi.org/10.2139/ssrn.3373594

David J Allen

Plato Investment Management ( email )

Level 14, 167 Macquarie St
Sydney, New South Wales 2066
Australia
2407346111 (Phone)
2000 (Fax)

University of Technology, Sydney ( email )

15 Broadway, Ultimo
PO Box 123
Sydney, NSW 2007
Australia

Colin M. Lizieri (Contact Author)

University of Cambridge - Department of Land Economy ( email )

19 Silver Street
Cambridge, CB3 9EP
United Kingdom

HOME PAGE: http://www.landecon.cam.ac.uk/staff/profiles/clizieri.htm

Stephen E. Satchell

University of Cambridge - Faculty of Economics and Politics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom
44 (0)1223 335213 (Phone)
44 (0)1223 335475 (Fax)

HOME PAGE: http://www.econ.cam.ac.uk/faculty/satchell/index.h

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