Portfolios from Sorts
22 Pages Posted: 12 May 2005
Date Written: April 27, 2005
Modern portfolio theory produces an optimal portfolio from estimates of expected returns and a covariance matrix. We present a method for portfolio optimization based on replacing expected returns with ordering information, that is, with information about the order of the expected returns. We give a simple and economically rational definition of optimal portfolios that extends Markowitz' meanvariance optimality condition in a natural way; in particular, our construction allows full use of covariance information. We also provide efficient numerical algorithms. The formulation we develop is very general and is easily extended to a variety of cases, for example, where assets are divided into multiple sectors or there are multiple sorting criteria available.
Keywords: optimal portfolios, portfolio choice, portfolio optimization, optimization theory, convex optimization, asset pricing, capm
JEL Classification: C61, G11, G12
Suggested Citation: Suggested Citation