Portfolio optimization using forward-looking information
AbstractIn this paper we develop the first estimator of the covariance matrix that relies solely on forward-looking information. This estimator only uses price information from a cross-section of plain-vanilla options. In an out-of-sample study for US blue-chip stocks we show that a minimum-variance strategy based on this fully implied estimator consistently outperforms a wide range of benchmark strategies, including strategies based on historical estimates, index investing, and investing according to the 1/N rule. The outperformance is strong in periods of high information asymmetry, whereas in quiet periods all strategies lead to similar results. The outperformance can only be reached using a fully implied approach; partially implied approaches that combine implied moments with historical ones might even perform worse than purely historical approaches. --
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Bibliographic InfoPaper provided by University of Cologne, Centre for Financial Research (CFR) in its series CFR Working Papers with number 11-10.
Date of creation: 2011
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Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-10-09 (All new papers)
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