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Implied Expected Returns and the Choice of a Mean-Variance Efficient Portfolio Proxy

Author

Listed:
  • David Ardia
  • Kris Boudt

Abstract

We propose to compute the implied expected returns from several candidate mean-variance efficient portfolios, exploiting the fundamental relation between the expected returns, covariance matrix and the corresponding set of mean-variance efficient portfolios. Over the 1987-2012 period and for the universe of S&P 100 stocks, we find that a mean-variance efficient investor would have been willing to pay between a 1.7% and 4.2% management fee to switch from mean-variance investing using implied expected returns from the market capitalization weighted portfolio to mean-variance investing using the implied expected returns from the equal-risk-contribution portfolio.

Suggested Citation

  • David Ardia & Kris Boudt, 2013. "Implied Expected Returns and the Choice of a Mean-Variance Efficient Portfolio Proxy," Cahiers de recherche 1328, CIRPEE.
    • Handle: RePEc:lvl:lacicr:1328
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    File URL: http://www.cirpee.org/fileadmin/documents/Cahiers_2013/CIRPEE13-28.pdf
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    References listed on IDEAS

    as
    1. Chen, Chen & Chen, Rong & Bassett, Gilbert W., 2007. "Fundamental indexation via smoothed cap weights," Journal of Banking & Finance, Elsevier, vol. 31(11), pages 3486-3502, November.
    2. repec:dau:papers:123456789/4688 is not listed on IDEAS
    3. Xiaohui NI & Yannick MALEVERGNE & Didier SORNETTE & Peter WOEHRMANN, 2011. "Robust reverse engineering of crosssectional returns and improved portfolio allocation performance using the CAPM," Swiss Finance Institute Research Paper Series 11-03, Swiss Finance Institute.
    4. Das, Sanjiv & Markowitz, Harry & Scheid, Jonathan & Statman, Meir, 2010. "Portfolio Optimization with Mental Accounts," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(2), pages 311-334, April.
    5. Ledoit, Olivier & Wolf, Michael, 2003. "Improved estimation of the covariance matrix of stock returns with an application to portfolio selection," Journal of Empirical Finance, Elsevier, vol. 10(5), pages 603-621, December.
    6. Jorion, Philippe, 1986. "Bayes-Stein Estimation for Portfolio Analysis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(3), pages 279-292, September.
    7. Best, Michael J & Grauer, Robert R, 1985. "Capital Asset Pricing Compatible with Observed Market Value Weights," Journal of Finance, American Finance Association, vol. 40(1), pages 85-103, March.
    8. Moshe Levy & Richard Roll, 2010. "The Market Portfolio May Be Mean/Variance Efficient After All," The Review of Financial Studies, Society for Financial Studies, vol. 23(6), pages 2464-2491, June.
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    Cited by:

    1. David Ardia & Guido Bolliger & Kris Boudt & Jean-Philippe Gagnon-Fleury, 2017. "The impact of covariance misspecification in risk-based portfolios," Annals of Operations Research, Springer, vol. 254(1), pages 1-16, July.

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    More about this item

    Keywords

    Implied expected return; mean-variance; model selection; portfolio allocation; reverse engineering; risk-based allocation;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C31 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions; Social Interaction Models

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