Rational Explanation for Rule-of-Thumb Practices in Asset Allocation

DOI:10.1080/14697688.2019.1622767

26 Pages Posted: 5 Sep 2019

See all articles by Majeed Simaan

Majeed Simaan

Stevens Institute of Technology - School of Business

Yusif Simaan

Fordham University - Graduate School of Business

Date Written: May 5, 2019

Abstract

Naive asset allocation and other ad-hoc techniques are commonly practiced by fund managers in the industry. Such strategies, however, are deemed mean-variance (MV) sub-optimal according to modern portfolio theory. Nonetheless, taking estimation risk into considerations, such practices are consistent with rational theory. In practice, the potential advantage of MV optimization is weighed against the severity of estimation risk. This paper proposes a set of decision rules to determine the optimal fund under estimation risk. A mixed strategy that deploys the proposed decision rules implies a convex improvement in terms of out-of-sample Sharpe-ratio.

Keywords: Portfolio Theory, Investment, Estimation Risk, Naive Allocation

JEL Classification: C13, C44, C46, G11

Suggested Citation

Simaan, Majeed and Simaan, Yusif, Rational Explanation for Rule-of-Thumb Practices in Asset Allocation (May 5, 2019). DOI:10.1080/14697688.2019.1622767. Available at SSRN: https://ssrn.com/abstract=3391412

Majeed Simaan (Contact Author)

Stevens Institute of Technology - School of Business ( email )

Hoboken, NJ 07030
United States

Yusif Simaan

Fordham University - Graduate School of Business ( email )

113 West 60th Street
Bronx, NY 10458
United States
6462200652 (Phone)

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