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Robust Mean-Variance Portfolio Selection

  • Cédric Perret-Gentil

    ()

    (Union Bancaire Privée)

  • Maria-Pia Victoria-Feser

    ()

    (HEC,University of Geneva)

Registered author(s):

    This paper investigates model risk issues in the context of mean-variance portfolio selection. We analytically and numerically show that, under model misspecification, the use of statistically robust estimates instead of the widely used classical sample mean and covariance is highly beneficial for the stability properties of the mean-variance optimal portfolios. Moreover, we perform simulations leading to the conclusion that, under classical estimation, model risk bias dominates estimation risk bias. Finally, we suggest a diagnostic tool to warn the analyst of the presence of extreme returns that have an abnormally large influence on the optimization results.

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    File URL: http://www.swissfinanceinstitute.ch/rp140.pdf
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    Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp140.

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    Date of creation: Apr 2005
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    Handle: RePEc:fam:rpseri:rp140
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    1. Mark Britten-Jones, 1999. "The Sampling Error in Estimates of Mean-Variance Efficient Portfolio Weights," Journal of Finance, American Finance Association, vol. 54(2), pages 655-671, 04.
    2. Alexander, Gordon J & Resnick, Bruce G, 1985. " More on Estimation Risk and Simple Rules for Optimal Portfolio Selection," Journal of Finance, American Finance Association, vol. 40(1), pages 125-33, March.
    3. Barry, Christopher B, 1974. "Portfolio Analysis under Uncertain Means, Variances, and Covariances," Journal of Finance, American Finance Association, vol. 29(2), pages 515-22, May.
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