Reducing estimation risk in optimal portfolio selection when short sales are allowed

Gordon J. Alexander, Alexandre M. Baptista, Shu Yan

Research output: Contribution to journalArticlepeer-review

5 Scopus citations

Abstract

The issue of estimation risk is of particular interest to the decision-making processes of portfolio managers who use long-short investment strategies. Accordingly, our paper explores the question of whether a VaR constraint reduces estimation risk when short sales are allowed. We find that such a constraint notably decreases errors in estimates of the expected return, standard deviation, and VaR of optimal portfolios. Furthermore, optimal portfolios in the presence of the constraint are substantially closer to the 'true' efficient frontier than those in its absence. Finally, we provide VaR bounds and confidence levels for the constraint that lead to the best out-of-sample performance. copyright

Original languageEnglish (US)
Pages (from-to)281-305
Number of pages25
JournalManagerial and Decision Economics
Volume30
Issue number5
DOIs
StatePublished - Jul 1 2009

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