It’s All in the Timing: Simple Active Portfolio Strategies that Outperform Naïve Diversification

DeMiguel, Garlappi, and Uppal (2009) report that naïve diversification dominates mean-variance optimization in out-of-sample asset allocation tests. Our analysis suggests that this is largely due to their research design, which focuses on portfolios that are subject to high estimation risk and extre...

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Bibliographic Details
Published inJournal of financial and quantitative analysis Vol. 47; no. 2; pp. 437 - 467
Main Authors Kirby, Chris, Ostdiek, Barbara
Format Journal Article
LanguageEnglish
Published New York, USA Cambridge University Press 01.04.2012
Subjects
Asset allocation
Cost estimates
Datasets
Diversification
Estimators
Fees
Financial portfolios
Investors
Optimization
Portfolio diversification
Portfolio management
Portfolios
Statistical significance
Statistical variance
Transaction costs
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Summary:DeMiguel, Garlappi, and Uppal (2009) report that naïve diversification dominates mean-variance optimization in out-of-sample asset allocation tests. Our analysis suggests that this is largely due to their research design, which focuses on portfolios that are subject to high estimation risk and extreme turnover. We find that mean-variance optimization often outperforms naïve diversification, but turnover can erode its advantage in the presence of transaction costs. To address this issue, we develop 2 new methods of mean-variance portfolio selection (volatility timing and reward-to-risk timing) that deliver portfolios characterized by low turnover. These timing strategies outperform naïve diversification even in the presence of high transaction costs.
Bibliography:ObjectType-Article-1
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ISSN:0022-1090
1756-6916
DOI:10.1017/S0022109012000117