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A Stability Approach to Mean-Variance Optimization

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  • Apostolos Kourtis

Abstract

I jointly treat two critical issues in the application of mean-variance portfolios, that is, estimation risk and portfolio instability. I find that theory-based portfolio strategies, which are known to outperform naive diversification ( 1 / N ) in the absence of transaction costs, heavily underperform it under transaction costs. This is because they are highly unstable over time. I propose a generic method to stabilize any given portfolio strategy while maintaining or improving its efficiency. My empirical analysis confirms that the new method leads to stable and efficient portfolios that offer equal or lower turnover than 1 / N and larger Sharpe ratio, even under high transaction costs.

Suggested Citation

  • Apostolos Kourtis, 2015. "A Stability Approach to Mean-Variance Optimization," The Financial Review, Eastern Finance Association, vol. 50(3), pages 301-330, August.
    • Handle: RePEc:bla:finrev:v:50:y:2015:i:3:p:301-330
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    File URL: http://hdl.handle.net/10.1111/fire.12068
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    Cited by:

    1. Kircher, Felix & Rösch, Daniel, 2021. "A shrinkage approach for Sharpe ratio optimal portfolios with estimation risks," Journal of Banking & Finance, Elsevier, vol. 133(C).
    2. Francisco Fernández-Navarro & Luisa Martínez-Nieto & Mariano Carbonero-Ruz & Teresa Montero-Romero, 2021. "Mean Squared Variance Portfolio: A Mixed-Integer Linear Programming Formulation," Mathematics, MDPI, vol. 9(3), pages 1-13, January.
    3. Platanakis, Emmanouil & Sakkas, Athanasios & Sutcliffe, Charles, 2019. "Harmful diversification: Evidence from alternative investments," The British Accounting Review, Elsevier, vol. 51(1), pages 1-23.
    4. Tatarnikova, Olga & Duchêne, Sébastien & Sentis, Patrick & Willinger, Marc, 2023. "Portfolio instability and socially responsible investment: Experiments with financial professionals and students," Journal of Economic Dynamics and Control, Elsevier, vol. 153(C).
    5. Dragicevic, Arnaud Z., 2019. "Rethinking the forestry in the Aquitaine massif through portfolio management," Forest Policy and Economics, Elsevier, vol. 109(C).
    6. Bian, Zhicun & Liao, Yin & O’Neill, Michael & Shi, Jing & Zhang, Xueyong, 2020. "Large-scale minimum variance portfolio allocation using double regularization," Journal of Economic Dynamics and Control, Elsevier, vol. 116(C).
    7. Apostolos Kourtis & Raphael N. Markellos & Lazaros Symeonidis, 2016. "An International Comparison of Implied, Realized, and GARCH Volatility Forecasts," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 36(12), pages 1164-1193, December.

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