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Bayes-Stein Estimation for Portfolio Analysis

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  • Jorion, Philippe

Abstract

In portfolio analysis, uncertainty about parameter values leads to suboptimal portfolio choices. The resulting loss in the investor's utility is a function of the particular estimator chosen for expected returns. So, this is a problem of simultaneous estimation of normal means under a well-specified loss function. In this situation, as Stein has shown, the classical sample mean is inadmissible. This paper presents a simple empirical Bayes estimator that should outperform the sample mean in the context of a portfolio. Simulation analysis shows that these Bayes-Stein estimators provide significant gains in portfolio selection problems.

Suggested Citation

  • 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.
  • Handle: RePEc:cup:jfinqa:v:21:y:1986:i:03:p:279-292_01
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