How Much Should Portfolios Shrink?

Han, C.

Abstract

This paper develops a portfolio model that penalizes the deviation from a reference portfolio. The proposed model renders a robust portfolio that performs superior under parameter uncertainty. Penalizing the deviation also improves the performance of existing shrinkage portfolio models that are sub‐optimal due to model parameter uncertainty. The equal‐weight portfolio turns out to be a better reference portfolio than the currently holding portfolio even in the presence of transaction costs. A data‐driven method for determining the degree of penalization is offered. Comprehensive simulation and empirical studies suggest that the proposed model significantly outperforms various existing models.

Citation

Han, C. (2020). How Much Should Portfolios Shrink?. Financial Management, 49(3), 707-740. https://doi.org/10.1111/fima.12282

• Journal Article Type: Article
• Acceptance Date: Jun 18, 2019
• Online Publication Date: Aug 1, 2019
• Publication Date: Sep 3, 2020
• Deposit Date: Jun 26, 2019
• Publicly Available Date: Aug 1, 2020
• Journal: Financial Management
• Print ISSN: 0046-3892
• Electronic ISSN: 1755-053X
• Publisher: Wiley
• Peer Reviewed: Peer Reviewed
• Volume: 49
• Issue: 3
• Pages: 707-740
• DOI: https://doi.org/10.1111/fima.12282
• Public URL: https://durham-repository.worktribe.com/output/1327911