Abstract
In this study, we present a multi-objective approach based on a mean-variance-skewness-entropy portfolio selection model (MVSEM). In this approach, an entropy measure is added to the mean-variance-skewness model (MVSM) to generate a well‑diversified portfolio. Through a variety of empirical data sets, we evaluate the performance of the MVSEM in terms of several portfolio performance measures. The obtained results show that the MVSEM performs well out-of sample relative to traditional portfolio selection models.
Highlights
Markowitz’s mean-variance model (MVM), which is based on the assumption that returns of assets follow a normal distribution, has been accepted as a pioneer portfolio selection model [1]
Based on three different empirical datasets, we evaluate the out-of-sample performance of mean-varianceskewness-entropy portfolio selection model (MVSEM) relative to well-known portfolio models such as the weighted model (EWM), minimum variance model (MinVM), MVM and meanvariance-skewness model (MVSM)
We evaluate empirically the performances of the MVSEM with the chosen (λ1, λ2, λ3 ) relative to the equally weighted model (EWM), MinVM, MVM and MVSM using 20 industry portfolios, 7 international portfolios, 15 Istanbul Stock Exchange (ISE)
Summary
Markowitz’s mean-variance model (MVM), which is based on the assumption that returns of assets follow a normal distribution, has been accepted as a pioneer portfolio selection model [1]. Prakash et al [4], Harvey et al [8] and Ibbotson [10] discuss existence of the higher moments in an asset allocation system if the returns do not follow a symmetrical probability distribution They show that when skewness is included in the decision process, an investor can get a higher return. Some studies indicate that [2,4,11] that the portfolio weights obtained from the MVM and the MVSM can often focus on a few assets or extreme positions, an important objective of asset allocation is diversification [11,12] In portfolio theory, it is well-known that the diversification reduces unsystematic risk in portfolios.
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