Approximating the Numeraire Portfolio by Naive Diversification
Estimation theory has shown, due to the limited estimation window available for real asset data, the sample based Markowitz mean-variance approach produces unreliable weights which fluctuate substantially over time. This paper proposes an alternate approach to portfolio optimization, being the use of naive diversification to approximate the numeraire portfolio. The numeraire portfolio is the strictly positive portfolio that, when used as benchmark, makes all benchmarked nonnegative portfolios either mean decreasing or trendless. Furthermore, it maximizes expected logarithmic utility and outperforms any other strictly positive portfolio in the long run. The paper proves for a well-securitized market that the naive equal value weighted portfolio converges to the numeraire portfolio when the number of constituents tends to infinity. This result is model independent and, therefore, very robust.The systematic construction of diversified stock indices by naive diversification from real data is demonstrated. Even when taking transaction costs into account, these indices significantly outperform the corresponding market capitalization weighted indices in the long run, indicating empirically their asymptotic proximity to the numeraire portfolio. Empirical evidence is presented that the Sharpe ratios of equi-weighted indices surpass significantly those of corresponding market capitalization weighted indices. This empirical stylized fact applies also to the market portfolio of equity markets of countries, which questions the applicability of the intertemporal capital asset pricing model. Finally, in time of financial crisis, a large equi-weighted fund carrying the investments of the major pension funds and insurance companies would provide important liquidity. It would not only dampen the extremes of a crisis but would also moderate the excesses of any asset price bubble.
To our knowledge, this item is not available for
download. To find whether it is available, there are three
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
|Date of creation:||01 Aug 2010|
|Date of revision:|
|Publication status:||Published as: Platen, E. and Rendek, R., 2012, "Approximating the Numeraire Portfolio by Naive Diversification", Journal of Asset Management, 13(1), 34-50.|
|Contact details of provider:|| Postal: PO Box 123, Broadway, NSW 2007, Australia|
Phone: +61 2 9514 7777
Fax: +61 2 9514 7711
Web page: http://www.qfrc.uts.edu.au/
More information through EDIRC
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.:
- Rubinstein, Mark, 1976. "The Strong Case for the Generalized Logarithmic Utility Model as the Premier Model of Financial Markets," Journal of Finance, American Finance Association, vol. 31(2), pages 551-71, May.
- Eckhard Platen & Renata Rendek, 2009.
"Simulation of Diversified Portfolios in a Continuous Financial Market,"
Research Paper Series
264, Quantitative Finance Research Centre, University of Technology, Sydney.
- Eckhard Platen & Renata Rendek, 2010. "Simulation of Diversified Portfolios in a Continuous Financial Market," Research Paper Series 282, Quantitative Finance Research Centre, University of Technology, Sydney.
- Constantinos Kardaras & Eckhard Platen, 2008. "On Financial Markets where only Buy-And-Hold Trading is Possible," Research Paper Series 213, Quantitative Finance Research Centre, University of Technology, Sydney.
- Damir Filipović & Eckhard Platen, 2009.
"Consistent Market Extensions Under The Benchmark Approach,"
Wiley Blackwell, vol. 19(1), pages 41-52.
- Damir Filipovic & Eckhard Platen, 2007. "Consistent Market Extensions under the Benchmark Approach," Research Paper Series 189, Quantitative Finance Research Centre, University of Technology, Sydney.
- Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
- Eckhard Platen, 2001. "Arbitrage in Continuous Complete Markets," Research Paper Series 72, Quantitative Finance Research Centre, University of Technology, Sydney.
- Eckhard Platen, 2004.
"A Benchmark Framework for Risk Management,"
World Scientific Book Chapters,
in: Stochastic Processes And Applications To Mathematical Finance, chapter 15, pages 305-335
World Scientific Publishing Co. Pte. Ltd..
- Eckhard Platen, 2004.
"A Benchmark Approach to Finance,"
Research Paper Series
138, Quantitative Finance Research Centre, University of Technology, Sydney.
- Markowitz, Harry M, 1976. "Investment for the Long Run: New Evidence for an Old Rule," Journal of Finance, American Finance Association, vol. 31(5), pages 1273-86, December.
- Hakansson, Nils H., 1971. "Capital Growth and the Mean-Variance Approach to Portfolio Selection," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 6(01), pages 517-557, January.
- Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
- Henry Allen Latane, 1959. "Criteria for Choice Among Risky Ventures," Journal of Political Economy, University of Chicago Press, vol. 67, pages 144.
- Best, Michael J & Grauer, Robert R, 1991. "On the Sensitivity of Mean-Variance-Efficient Portfolios to Changes in Asset Means: Some Analytical and Computational Results," Review of Financial Studies, Society for Financial Studies, vol. 4(2), pages 315-42.
- Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942, December.
- Hans Buhlmann & Eckhard Platen, 2002. "A Discrete Time Benchmark Approach for Finance and Insurance," Research Paper Series 74, Quantitative Finance Research Centre, University of Technology, Sydney.
- Thomas M. Cover, 1991. "Universal Portfolios," Mathematical Finance, Wiley Blackwell, vol. 1(1), pages 1-29.
When requesting a correction, please mention this item's handle: RePEc:uts:rpaper:281. 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: (Duncan Ford)
If references are entirely missing, you can add them using this form.