Abstract
Mean-variance portfolio theory remains frequently used as an investment rationale because of its simplicity, its closed-form solution, and the availability of well-performing robust estimators. At the same time, it is also frequently rejected on the grounds that it ignores the higher moments of non-Gaussian returns. However, higher-moment portfolios are associated with many different objective functions, are numerically more complex, and exacerbate estimation risk. In this paper, we reconcile mean-variance portfolio theory with non-Gaussian returns by identifying, among all portfolios on the mean-variance efficient frontier, the one that optimizes a chosen higher-moment criterion. Numerical simulations and an empirical analysis show, for three higher-moment objective functions and adjusting for transaction costs, that the proposed portfolio strikes a favorable tradeoff between specification and estimation error. Specifically, in terms of out-of-sample Sharpe ratio and higher moments, it outperforms the global-optimal portfolio, and also the global-minimum-variance portfolio except when using monthly returns for which estimation error is more prominent.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
