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Risk Reduction in Large Portfolios: Why Imposing the Wrong Constraints Helps
Open accessAbstract
Green and Hollifield (1992) argue that the presence of a dominant factor would result in extreme negative weights in mean‐variance efficient portfolios even in the absence of estimation errors. In that case, imposing no‐short‐sale constraints should hurt, whereas empirical evidence is often to the contrary. We reconcile this apparent contradiction. We explain why constraining portfolio weights to be nonnegative can reduce the risk in estimated optimal portfolios even when the constraints are wrong. Surprisingly, with no‐short‐sale constraints in place, the sample covariance matrix performs as well as covariance matrix estimates based on factor models, shrinkage estimators, and daily data.
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Cites
Common risk factors in the returns on stocks and bonds
Fama, E. F., & French, K. R. (1993) · Journal of Financial Economics · doi:10.1016/0304-405x(93)90023-5 · Cited by 25,754
Cited by
Optimal Versus Naive Diversification: How Inefficient is the 1/ N Portfolio Strategy?
DeMiguel, V., Garlappi, L., & Uppal, R. (2009) · Review of Financial Studies · doi:10.1093/rfs/hhm075 · Cited by 3,199
Chapter 4 Forecast Combinations
Timmermann, A. (2006) · Handbook of Economic Forecasting · doi:10.1016/s1574-0706(05)01004-9 · Cited by 1,314
60 Years of portfolio optimization: Practical challenges and current trends
Kolm, P. N., Tütüncü, R., & Fabozzi, F. J. (2014) · European Journal of Operational Research · doi:10.1016/j.ejor.2013.10.060 · Cited by 632
Gomes, F., Haliassos, M., & Ramadorai, T. (2021) · Journal of Economic Literature · doi:10.1257/jel.20201461 · Cited by 396
Portfolio Selection with Parameter and Model Uncertainty: A Multi-Prior Approach
Garlappi, L., Wang, T., & Uppal, R. (2004) · SSRN Electronic Journal · doi:10.2139/ssrn.671981 · Cited by 264
Metadata
- Authors
- Jagannathan, R., & Ma, T.
- Venue
- The Journal of Finance
- Publisher
- Wiley
- Published
- 2003-07-15
- Volume
- 58
- Issue
- 4
- Pages
- 1651-1683
- ISSN
- 0022-1082 (ISSN-L)
- 1540-6261
- OpenAlex
- W2891118671
- Cited by
- 1,462
- References
- 1
- FWCI
- 29.44
- Type
- journal article
- Language
- en
- Open access
- bronze
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Contains information from the Semantic Scholar Academic Graph Datasets, made available under the ODC Attribution License (ODC-BY 1.0).
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