On the base of which returns do I have to derive optimal portfolio weights of an investment strategy? More specifically, do I have to use the excess returns or just the normal returns of the respective assets? I'd appreciate any help!
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3$\begingroup$ Hi: it depends on the benchmark your comparing your portfiolio to. If you're comparing it to the risk-free rate, then should use the excess returns ( returns - risk-free rate ). if you're comparing against nothing ( just trying to see what the return would return over zero ), then you should use the raw returns. $\endgroup$– mark leedsMar 1, 2020 at 12:06
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$\begingroup$ Makes sense! Thanks a lot $\endgroup$– Dirty DanMar 1, 2020 at 17:56
1 Answer
Unless you have a specific benchmark that you have to outperform, I would simply use the raw returns of the portfolio as opposed to any sort of excess returns over a benchmark. In the end, you will likely to be backtesting your whole strategy, portfolio selection and rebalancing included and you'd presumably be looking into metrics such as Sharp ratios, maximal drawdown, kurtosis, etc. It just seems like using only raw returns saves you a lot of trouble in that context.