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Enhancing mean–variance portfolio selection by modeling distributional asymmetries

Author

Listed:
  • Yew Low, Rand Kwong
  • Faff, Robert
  • Aas, Kjersti

Abstract

Why do mean–variance (MV) models perform so poorly? In searching for an answer to this question, we estimate expected returns by sampling from a multivariate probability model that explicitly incorporates distributional asymmetries. Specifically, our empirical analysis shows that an application of copulas using marginal models that incorporate dynamic features such as autoregression, volatility clustering, and skewness to reduce estimation error in comparison to historical sampling windows. Using these copula-based models, we find that several MV-based rules exhibit statistically significant and superior performance improvements even after accounting for transaction costs. However, we find that outperforming the naïve equally-weighted (1/N) strategy after accounting for transactions costs still remains an elusive task.

Suggested Citation

  • Yew Low, Rand Kwong & Faff, Robert & Aas, Kjersti, 2016. "Enhancing mean–variance portfolio selection by modeling distributional asymmetries," Journal of Economics and Business, Elsevier, vol. 85(C), pages 49-72.
    • Handle: RePEc:eee:jebusi:v:85:y:2016:i:c:p:49-72
    DOI: 10.1016/j.jeconbus.2016.01.003
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    Citations

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    Cited by:

    1. Rad, Hossein & Low, Rand Kwong Yew & Miffre, Joëlle & Faff, Robert, 2020. "Does sophistication of the weighting scheme enhance the performance of long-short commodity portfolios?," Journal of Empirical Finance, Elsevier, vol. 58(C), pages 164-180.
    2. Huang, Jiexiang & Guo, Wei & Zhang, Jin E., 2020. "Do stocks outperform bank deposits in China?," Pacific-Basin Finance Journal, Elsevier, vol. 64(C).
    3. Sleire, Anders D. & Støve, Bård & Otneim, Håkon & Berentsen, Geir Drage & Tjøstheim, Dag & Haugen, Sverre Hauso, 2022. "Portfolio allocation under asymmetric dependence in asset returns using local Gaussian correlations," Finance Research Letters, Elsevier, vol. 46(PB).
    4. Clara Calvo & Carlos Ivorra & Vicente Liern & Blanca Pérez-Gladish, 2021. "Grading Investment Diversification Options in Presence of Non-Historical Financial Information," Mathematics, MDPI, vol. 9(6), pages 1-11, March.
    5. Rad, Hossein & Low, Rand Kwong Yew & Miffre, Joëlle & Faff, Robert, 2022. "The strategic allocation to style-integrated portfolios of commodity futures," Journal of Commodity Markets, Elsevier, vol. 28(C).
    6. Md Saiful Islam & Md Sarowar Morshed & Md. Noor-E-Alam, 2022. "A Computational Framework for Solving Nonlinear Binary Optimization Problems in Robust Causal Inference," INFORMS Journal on Computing, INFORMS, vol. 34(6), pages 3023-3041, November.
    7. Michael R. Metel & Traian A. Pirvu & Julian Wong, 2017. "Risk Management under Omega Measure," Risks, MDPI, vol. 5(2), pages 1-14, May.
    8. Masoud Rahiminezhad Galankashi & Farimah Mokhatab Rafiei & Maryam Ghezelbash, 2020. "Portfolio selection: a fuzzy-ANP approach," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 6(1), pages 1-34, December.
    9. Hanif, Waqas & Areola Hernandez, Jose & Troster, Victor & Kang, Sang Hoon & Yoon, Seong-Min, 2022. "Nonlinear dependence and spillovers between cryptocurrency and global/regional equity markets," Pacific-Basin Finance Journal, Elsevier, vol. 74(C).
    10. Wu, Chih-Chiang & Chen, Wei-Peng & Korsakul, Nattawadee, 2021. "Extreme linkages between foreign exchange and general financial markets," Pacific-Basin Finance Journal, Elsevier, vol. 65(C).
    11. Emmanuel Afuecheta & Saralees Nadarajah & Stephen Chan, 2021. "A Statistical Analysis of Global Economies Using Time Varying Copulas," Computational Economics, Springer;Society for Computational Economics, vol. 58(4), pages 1167-1194, December.
    12. Beatrice D. Simo-Kengne & Kofi A. Ababio & Jules Mba & Ur Koumba, 2018. "Behavioral portfolio selection and optimization: an application to international stocks," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 32(3), pages 311-328, August.

    More about this item

    Keywords

    Mean–variance; Portfolio management; Copula; Asymmetric marginals;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C16 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Econometric and Statistical Methods; Specific Distributions

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