The Risk of Out-of-Sample Portfolio Performance

82 Pages Posted: 1 Jun 2021 Last revised: 8 Apr 2022

See all articles by Nathan Lassance

Nathan Lassance

LFIN/LIDAM, UCLouvain

Alberto Martin-Utrera

Iowa State University

Majeed Simaan

Stevens Institute of Technology - School of Business

Date Written: April 8, 2022

Abstract

We show theoretically and empirically that estimated portfolios bear substantial out-of-sample utility risk in high-dimensional settings or when these portfolios exploit in-sample near-arbitrage opportunities. We use our novel analytical characterization of out-of-sample utility risk to propose a robustness measure that balances out-of-sample utility mean and volatility. We demonstrate that while individual portfolios do not offer maximal robust performance, portfolio combinations achieve the optimal tradeoff between out-of-sample utility mean and volatility and are more resilient to estimation errors. Our analysis of out-of-sample performance risk has implications for constructing and evaluating quantitative investment strategies and models of the stochastic discount factor.

Keywords: parameter uncertainty, mean-variance portfolio, shrinkage

JEL Classification: G11, G12

Suggested Citation

Lassance, Nathan and Martin-Utrera, Alberto and Simaan, Majeed, The Risk of Out-of-Sample Portfolio Performance (April 8, 2022). Available at SSRN: https://ssrn.com/abstract=3855546 or http://dx.doi.org/10.2139/ssrn.3855546

Nathan Lassance (Contact Author)

LFIN/LIDAM, UCLouvain ( email )

151 Chaussée de Binche
Mons, 7000
Belgium

Alberto Martin-Utrera

Iowa State University ( email )

613 Wallace Road
Ames, IA 50011-2063
United States

Majeed Simaan

Stevens Institute of Technology - School of Business ( email )

Hoboken, NJ 07030
United States

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