A Linear Weight Estimator for Dynamic Global Minimum Variance Portfolio Allocation

40 Pages Posted: 11 Mar 2022 Last revised: 30 Nov 2023

See all articles by Ekaterina Kazak

Ekaterina Kazak

University of Manchester

Yifan Li

The University of Manchester - Alliance Manchester Business School; Lancaster University - Department of Accounting and Finance

Ingmar Nolte

Lancaster University - Department of Accounting and Finance

Sandra Nolte (Lechner)

Lancaster University Management School

Date Written: October 25, 2023

Abstract

This paper introduces a linear weight estimation (LWE) framework as a novel semi-parametric method for dynamic global minimum variance portfolio (GVMP) allocation. The LWE method assumes a dynamic linear model for the \textit{ex ante} optimal GMVP weights. Based on a time series of daily realized covariance estimates, the LWE model parameters can easily be estimated in closed form using the method of moments. Importantly, we prove that the estimated LWE portfolio weights directly and uniquely minimize a finite sample estimate of the unconditional portfolio variance, which is not achieved by most of the existing methods in the literature. Empirical results demonstrate that LWE outperforms competing estimators in terms of out-of-sample portfolio variance measures. LWE can also be extended to incorporate controls for investment constraints, which further balances its economic performance and transaction costs.

Keywords: portfolio allocation, high-frequency finance, realized measures, forecasting

JEL Classification: C51, C58, G11, C32

Suggested Citation

Kazak, Ekaterina and Li, Yifan and Nolte, Ingmar and Nolte (Lechner), Sandra, A Linear Weight Estimator for Dynamic Global Minimum Variance Portfolio Allocation (October 25, 2023). Available at SSRN: https://ssrn.com/abstract=4011298 or http://dx.doi.org/10.2139/ssrn.4011298

Ekaterina Kazak (Contact Author)

University of Manchester ( email )

Arthur Lewis Building
Oxford Road
Manchester, M13 9PL
United Kingdom

Yifan Li

The University of Manchester - Alliance Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster LA1 4YX
United Kingdom

Ingmar Nolte

Lancaster University - Department of Accounting and Finance ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

Sandra Nolte (Lechner)

Lancaster University Management School ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

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