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Resampling vs. Shrinkage for Benchmarked Managers


Wolf, Michael (2006). Resampling vs. Shrinkage for Benchmarked Managers. Working paper series / Institute for Empirical Research in Economics No. 263, University of Zurich.

Abstract

A well-known pitfall of Markowitz (1952) portfolio optimization is that the sample covariance matrix, which is a critical input, is very erroneous when there are many assets to choose from. Ifnunchecked, this phenomenon skews the optimizer towards extreme weights that tend to performnpoorly in the real world. One solution that has been proposed is to shrink the sample covariance matrix by pulling its most extreme elements towards more moderate values. An alternative solution is the resampled efficiency suggested by Michaud (1998). This paper compares shrinkagenestimation to resampled e*ciency. In addition, it studies whether the two techniques can bencombined to achieve a further improvement. All this is done in the context of an active port-nfolio manager who aims to outperform a benchmark index and who is evaluated by his realizedninformation ratio.

Abstract

A well-known pitfall of Markowitz (1952) portfolio optimization is that the sample covariance matrix, which is a critical input, is very erroneous when there are many assets to choose from. Ifnunchecked, this phenomenon skews the optimizer towards extreme weights that tend to performnpoorly in the real world. One solution that has been proposed is to shrink the sample covariance matrix by pulling its most extreme elements towards more moderate values. An alternative solution is the resampled efficiency suggested by Michaud (1998). This paper compares shrinkagenestimation to resampled e*ciency. In addition, it studies whether the two techniques can bencombined to achieve a further improvement. All this is done in the context of an active port-nfolio manager who aims to outperform a benchmark index and who is evaluated by his realizedninformation ratio.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Economics
Working Paper Series > Institute for Empirical Research in Economics (former)
Dewey Decimal Classification:330 Economics
Language:English
Date:January 2006
Deposited On:29 Nov 2011 22:47
Last Modified:07 Dec 2017 10:13
Series Name:Working paper series / Institute for Empirical Research in Economics
ISSN:1424-0459
Official URL:http://www.econ.uzh.ch/wp.html

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