Robust Portfolio Optimization with a Hybrid Heuristic Algorithm
Estimation errors in both the expected returns and the covariance matrix hamper the constructing of reliable portfolios within the Markowitz framework. Robust techniques that incorporate the uncertainty about the unknown parameters are suggested in the literature. We propose a modification as well as an extension of such a technique and compare both with another robust approach. In order to eliminate oversimplifications of Markowitz’ portfolio theory, we generalize the optimization framework to better emulate a more realistic investment environment. Because the adjusted optimization problem is no longer solvable with standard algorithms, we employ a hybrid heuristic to tackle this problem. Our empirical analysis is conducted with a moving time window for returns of the German stock index DAX100. The results of all three robust approaches yield more stable portfolio compositions than those of the original Markowitz framework. Moreover, the out-of-sample risk of the robust approaches is lower and less volatile while their returns are not necessarily smaller.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Peter Winker & Marianna Lyra & Chris Sharpe, 2008. "Least Median of Squares Estimation by Optimization Heuristics with an Application to the CAPM and Multi Factor Models," Working Papers 006, COMISEF.
- Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
- R.H. Tütüncü & M. Koenig, 2004. "Robust Asset Allocation," Annals of Operations Research, Springer, vol. 132(1), pages 157-187, November.
- Gianfranco Guastaroba & Renata Mansini & M. Speranza, 2009. "Models and Simulations for Portfolio Rebalancing," Computational Economics, Society for Computational Economics, vol. 33(3), pages 237-262, April.
- Manfred Gilli & Enrico Schumann, 2009. "Optimal enough?," Working Papers 010, COMISEF.
- Winker, Peter & Fang, Kai-Tai, 1995. "Application of threshold accepting to the evaluation of the discrepancy of a set of points," Discussion Papers, Series II 248, University of Konstanz, Collaborative Research Centre (SFB) 178 "Internationalization of the Economy".
- I. Roko & M. Gilli, 2008.
"Using economic and financial information for stock selection,"
Computational Management Science,
Springer, vol. 5(4), pages 317-335, October.
- Ilir Roko & Manfred Gilli, . "Using Economic and Financial Information for Stock Selection," Swiss Finance Institute Research Paper Series 06-21, Swiss Finance Institute.
When requesting a correction, please mention this item's handle: RePEc:com:wpaper:041. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Anil Khuman)
If references are entirely missing, you can add them using this form.