Mean-Variance Optimizations Versus Equal Weight
August 28, 2012 - Strategic Allocation
Does mean-variance optimization reliably beat simple equal weighting? In his August 2012 paper entitled “The Efficiency of Mean-Variance Optimization with In-depth Covariance Matrix Estimation and Portfolio Rebalancing”, Joonas Hämäläinen tests how many of 96 different mean-variance optimization implementations based on daily data outperform simple equal weighting after accounting for trading frictions. He considers three methods of determining weights for minimum variance portfolios. For each method, he considers three historical intervals for estimating optimal portfolio weights (20, 60 and 250 trading days). He considers three fixed-interval (5, 20 and 60 trading days) and one threshold-based rebalancing rules. His benchmark strategy is equal weight, rebalanced weekly (EW). He tests strategy combinations on four sets of asset returns in euros constructed from 23 MSCI country indexes: 11 European Monetary Union markets during June 2002 through May 2006 (EMU1) and during June 2006 through May 2010 (EMU2); and, 12 big emerging markets during June 2002 through May 2006 (BEM1) and during June 2006 through May 2010 (BEM2). He assumes constant trading frictions of 0.2% (0.4%) of traded value for EMU (BEM) data sets. He focuses on annualized net Sharpe ratio (with risk-free rate zero) and portfolio turnover as critical evaluation metrics. Using daily country total return index levels during June 2001 through May 2010, with out-of-sample tests commencing June 2002, he finds that: Keep Reading