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Choosing an optimal investment strategy: The role of robust pair-copulas based portfolios

  • Mendes, Beatriz Vaz de Melo
  • Marques, Daniel S.
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    This paper is concerned with the efficient allocation of a set of financial assets and its successful management. Efficient diversification of investments is achieved by inputing robust pair-copulas based estimates of the expected return and covariances in the mean-variance analysis of Markowitz. Although the whole point of diversifying a portfolio is to avoid rebalancing, very often one needs to rebalance to restore the portfolio to its original balance or target. But when and why to rebalance is a critical issue, and this paper investigates several managers' strategies to keep the allocations optimal. Findings for an emerging market target return and minimum risk investments are highly significant and convincing. Although the best strategy depends on the investor risk profile, it is empirically shown that the proposed robust portfolios always outperform the classical versions based on the sample estimates, yielding higher gains in the long run and requiring a smaller number of updates. We found that the pair-copulas based robust minimum risk portfolio monitored by a manager which checks its composition twice a year provides the best long run investment.

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    Article provided by Elsevier in its journal Emerging Markets Review.

    Volume (Year): 13 (2012)
    Issue (Month): 4 ()
    Pages: 449-464

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    Handle: RePEc:eee:ememar:v:13:y:2012:i:4:p:449-464
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    1. Klein, Roger W. & Bawa, Vijay S., 1976. "The effect of estimation risk on optimal portfolio choice," Journal of Financial Economics, Elsevier, vol. 3(3), pages 215-231, June.
    2. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
    3. Sanford J. Grossman & Zhongquan Zhou, 1993. "Optimal Investment Strategies For Controlling Drawdowns," Mathematical Finance, Wiley Blackwell, vol. 3(3), pages 241-276.
    4. Beatriz Mendes & Mariângela Semeraro & Ricardo Leal, 2010. "Pair-copulas modeling in finance," Financial Markets and Portfolio Management, Springer, vol. 24(2), pages 193-213, June.
    5. Hansen, B.E., 1992. "Autoregressive Conditional Density Estimation," RCER Working Papers 322, University of Rochester - Center for Economic Research (RCER).
    6. Nadine Gatzert & Hato Schmeiser & Stefan Schuckmann, 2008. "Enterprise risk management in financial groups: analysis of risk concentration and default risk," Financial Markets and Portfolio Management, Springer, vol. 22(3), pages 241-258, September.
    7. Canela, Miguel Angel & Collazo, Eduardo Pedreira, 2007. "Portfolio selection with skewness in emerging market industries," Emerging Markets Review, Elsevier, vol. 8(3), pages 230-250, September.
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