Focusing on the worst state for robust investing

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Despite its shortcomings, the Markowitz model remains the norm for asset allocation and portfolio construction. A major issue involves sensitivity of the model's solution to its input parameters. The prevailing approach employed by practitioners to overcome this problem is to use worst-case optimization. Generally, these methods have been adopted without incorporating equity market behavior and we believe that an analysis is necessary. Therefore, in this paper, we present the importance of market information during the worst state for achieving robust performance. We focus on the equity market and find that the optimal portfolio in a market with multiple states is the portfolio with robust returns and observe that focusing on the worst market state provides robust returns. Furthermore, we propose alternative robust approaches that emphasize returns during market down-side periods without solving worst-case optimization problems. Through our analyses, we demonstrate the value of focusing on the worst market state and as a result find support for the value of worst-case optimization for achieving portfolio robustness.
Publisher
ELSEVIER SCIENCE INC
Issue Date
2015-05
Language
English
Article Type
Article
Keywords

OPTIMAL PORTFOLIO CHOICE; STOCK-MARKET; ASSET ALLOCATION; BUSINESS-CYCLE; REGIME SHIFTS; BEAR MARKETS; SELECTION; OPTIMIZATION; MODELS; RETURNS

Citation

International Review of Financial Analysis, v.39, pp.19 - 31

ISSN
1057-5219
DOI
10.1016/j.irfa.2015.02.001
URI
http://hdl.handle.net/10203/198551
Appears in Collection
IE-Journal Papers(저널논문)
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