Portfolio Construction and Risk Budgeting
First published:
ISBN: 9781782721000
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Portfolio Resampling and Estimation Error
Introduction
A Primer on Portfolio Theory
Application in Mean–Variance Investing
Diversification
Frictional Costs of Diversification
Risk Parity
Incorporating Deviations from Normality: Lower Partial Moments
Portfolio Resampling and Estimation Error
Robust Portfolio Optimisation and Estimation Error
Bayesian Analysis and Portfolio Choice
Testing Portfolio Construction Methodologies Out-of-Sample
Portfolio Construction with Transaction Costs
Portfolio Optimisation with Options: From the Static Replication of CPPI Strategies to a More General Framework
Scenario Optimisation
Core–Satellite Investing: Budgeting Active Manager Risk
Benchmark-Relative Optimisation
Removing Long-Only Constraints: 120/20 Investing
Performance-Based Fees, Incentives and Dynamic Tracking Error Choice
Long-Term Portfolio Choice
Risk Management for Asset-Management Companies
Valuation of Asset Management Firms
Tail Risk Hedging
This chapter introduces estimation error as an additional problem for traditional Markowitz-based portfolio construction. In contrast with Chapter 9, which also deals with estimation error but with a more decision-theoretic foundation, this chapter presents two heuristic methods that seem to be widespread among practitioners. In Sections 7.1 and 7.2 we use Monte Carlo methods to visualise the effect of estimation error on portfolio construction. We will distinguish between estimation error (when the distribution parameters are stable but we do not have enough data) and non-stationarity (the distribution parameters are unstable). The next four sections focus on the main topic of this chapter: resampled efficiency as a meaningful concept for portfolio construction.11The patent for the procedure, issued in December 1999 under the title “Portfolio Optimization by Means of Resampled Efficient Frontiers”, is held by its inventors, Richard and Robert Michaud. The procedure is worldwide patent pending and New Frontier Advisors, LLC, Boston, MA, has been granted exclusive worldwide licensing rights. The chapter concludes with an interpretation of investment constraints in the light of
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