One of the main issues in portfolio selection models consists in assessing the effect of the estimation errors of the parameters required by the models on the quality of the selected portfolios. Several studies have been devoted to this topic for the minimum variance and for several other minimum risk models. However, no sensitivity analysis seems to have been reported for the recent popular Risk Parity diversification approach, nor for other portfolio selection models requiring maximum gain-risk ratios. Based on artificial and real-world data, we provide here empirical evidence showing that the Risk Parity model is always the most stable one in all the cases analyzed with respect to the portfolio composition. Furthermore, the minimum risk models are typically more stable than the maximum gain-risk models, with the minimum variance model often being the preferable one. The Risk Parity model seems to be the most stable one also with respect to profitability when measured by the Sharpe ratio. However, the maximum gain-risk models, although quite sensitive to the input data, generally appear to attain better profitability results.
On the stability of portfolio selection models / Francesco Cesarone; Fabiomassimo Mango; Carlo Domenico Mottura; Fabio Tardella; Jacopo Maria Ricci. - In: JOURNAL OF EMPIRICAL FINANCE. - ISSN 0927-5398. - (2020), pp. 1-25. [10.1016/j.jempfin.2020.10.003]
On the stability of portfolio selection models
Fabio Tardella;
2020
Abstract
One of the main issues in portfolio selection models consists in assessing the effect of the estimation errors of the parameters required by the models on the quality of the selected portfolios. Several studies have been devoted to this topic for the minimum variance and for several other minimum risk models. However, no sensitivity analysis seems to have been reported for the recent popular Risk Parity diversification approach, nor for other portfolio selection models requiring maximum gain-risk ratios. Based on artificial and real-world data, we provide here empirical evidence showing that the Risk Parity model is always the most stable one in all the cases analyzed with respect to the portfolio composition. Furthermore, the minimum risk models are typically more stable than the maximum gain-risk models, with the minimum variance model often being the preferable one. The Risk Parity model seems to be the most stable one also with respect to profitability when measured by the Sharpe ratio. However, the maximum gain-risk models, although quite sensitive to the input data, generally appear to attain better profitability results.File | Dimensione | Formato | |
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Cesarone_stability-portfolio_2020.pdf
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