Enhanced Portfolio Optimization

50 Pages Posted: 2 Mar 2020 Last revised: 14 Aug 2020

See all articles by Lasse Heje Pedersen

Lasse Heje Pedersen

AQR Capital Management, LLC; Copenhagen Business School - Department of Finance; New York University (NYU); Centre for Economic Policy Research (CEPR)

Abhilash Babu

AQR Capital Management, LLC

Ari Levine

AQR Capital Management

Date Written: January 2, 2020

Abstract

Portfolio optimization should provide large benefits to investors, but standard mean-variance optimization (MVO) works so poorly in practice that optimization is often abandoned. Several approaches have been developed to address this important issue, but they are often surrounded by mystique regarding how, why, and whether they really work. We seek to demystify, simplify, and enhance optimization: we identify the portfolios that cause problems in standard MVO and develop a simple enhanced portfolio optimization (EPO) method that addresses the problems. Applying EPO across equities and global asset classes, we find that EPO significantly enhances the performance of industry momentum and time series momentum factors, adding significant alpha beyond the market, the 1/N portfolio, risk parity, and standard asset pricing factors.

Keywords: portfolio choice, optimization, robustness, Black-Litterman, machine learning

JEL Classification: C58, C61, G11, G14

Suggested Citation

Pedersen, Lasse Heje and Babu, Abhilash and Levine, Ari, Enhanced Portfolio Optimization (January 2, 2020). Available at SSRN: https://ssrn.com/abstract=3530390 or http://dx.doi.org/10.2139/ssrn.3530390

Lasse Heje Pedersen (Contact Author)

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

New York University (NYU) ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Abhilash Babu

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Ari Levine

AQR Capital Management ( email )

Greenwich, CT
United States
2037423851 (Phone)

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
1,384
Abstract Views
3,879
rank
15,145
PlumX Metrics