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Asset Allocation by Variance Sensitivity Analysis

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  • Simone Manganelli

Abstract

This article provides a solution to the curse of dimensionality associated to multivariate generalized autoregressive conditionally heteroskedastic (GARCH) estimation. We work with univariate portfolio GARCH models and show how the multivariate dimension of the portfolio allocation problem may be recovered from the univariate approach. The main tool we use is "variance sensitivity analysis," the change in the portfolio variance induced by an infinitesimal change in the portfolio allocation. We suggest a computationally feasible method to find minimum variance portfolios and estimate full variance-covariance matrices. An application to real data portfolios implements our methodology and compares its performance against that of selected popular alternatives. Copyright 2004, Oxford University Press.

Suggested Citation

  • Simone Manganelli, 2004. "Asset Allocation by Variance Sensitivity Analysis," Journal of Financial Econometrics, Oxford University Press, vol. 2(3), pages 370-389.
    • Handle: RePEc:oup:jfinec:v:2:y:2004:i:3:p:370-389
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    File URL: http://hdl.handle.net/10.1093/jjfinec/nbh015
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    Citations

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    Cited by:

    1. Torben G. Andersen & Tim Bollerslev & Peter Christoffersen & Francis X. Diebold, 2007. "Practical Volatility and Correlation Modeling for Financial Market Risk Management," NBER Chapters, in: The Risks of Financial Institutions, pages 513-544, National Bureau of Economic Research, Inc.
    2. Manganelli, Simone, 2006. "A new theory of forecasting," Working Paper Series 584, European Central Bank.
    3. Chih-Nan Chen & Chien-Hsiu Lin, 2022. "Optimal carry trade portfolio choice under regime shifts," Review of Quantitative Finance and Accounting, Springer, vol. 59(2), pages 483-506, August.
    4. Manganelli, Simone, 2007. "Asset allocation by penalized least squares," Working Paper Series 723, European Central Bank.
    5. Marc S. Paolella, 2017. "The Univariate Collapsing Method for Portfolio Optimization," Econometrics, MDPI, vol. 5(2), pages 1-33, May.
    6. Eli Bouri & Andre Eid & Imad Kachacha, 2014. "The Dynamic Behaviour and Determinants of Linkages among Middle Eastern and North African Stock Exchanges," Economic Issues Journal Articles, Economic Issues, vol. 19(1), pages 1-22, March.
    7. Izhar, Hylmun, 2012. "Measuring Operational Risk Exposures in Islamic Banking: A Proposed Measurement Approach," Islamic Economic Studies, The Islamic Research and Training Institute (IRTI), vol. 20, pages 45-86.
    8. Bai, Zhidong & Li, Hua & Wong, Wing-Keung, 2013. "The best estimation for high-dimensional Markowitz mean-variance optimization," MPRA Paper 43862, University Library of Munich, Germany.
    9. Panayiotis F. Diamandis & Anastassios A. Drakos & Georgios P. Kouretas & Leonidas P. Zarangas, 2012. "Asset allocation in the Athens stock exchange: a variance sensitivity analysis," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 17(2), pages 167-181, April.
    10. Syriopoulos, Theodore & Roumpis, Efthimios, 2009. "Dynamic correlations and volatility effects in the Balkan equity markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 19(4), pages 565-587, October.

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