Minimising Operational Risk in Portfolio Allocation Decisions

Abstract

Models play an important role in strategic asset allocation (SAA), however by too much trust in the model stability, results are typically not so useful for practitioners. Professionals usually face the challenging problem of choosing a SAA model that matches their goals, bearing the operational risk of wrong choice (the model risk). Looking for helping them, this paper evaluates several methodologies of estimating efficient portfolios, under the perspective of global long-term investor, and also presents an approach (RATE) to incorporate estimation risk into mean-variance portfolio selection, based on the portfolio resampling technique. Our results support the use of the Michaud (1998) resampling methodology followed by the RATE, as they offer better results in terms of financial efficiency, allocation stability and diversification. In our evaluation of the different models we used several international asset classes for a period from June 1998 to July 2006. The findings are very useful for practitioners who can benefit from a fairly simple and robust asset allocation methodology.